Land Of Confusion
By Bas van Geffen, Senior Macro Strategist at Rabobank
The Bank of England managed to –again– catch markets by surprise, though this time by voting 8-1 in favor of a rate hike, moving the policy rate to 0.25%. The move leaves investors dumbfounded about the Bank’s communication strategy and reasoning. Back in November, the Monetary Policy Committee held off on a hike that was well-telegraphed ahead of the meeting, as policymakers judged that there was option value in waiting amidst high uncertainty about the outlook. It’s hard to see how the outlook has become any clearer between the November hold and yesterday’s hike, except for Omicron having spread rampantly around the country. Clearly, the Bank has moved the pandemic down its list of things to watch.
One of the main reasons to hike rates was the large increase in inflation. Inflation is certainly a valid concern, but as our UK Strategist argues, it remains the ‘wrong type’ of inflation. Moreover, it looks like the Bank seems to have ignored the trade-off that hiking interest rates in response to global price pressures means sacrificing domestic employment and output growth. The surprise move cemented the markets’ expectations of further hikes. We also believe that the MPC will hike again in the next few months, but expect the bank rate to remain at 0.50% until the end of 2022.
The Bank of England certainly isn’t the only one with a relatively sanguine view of Omicron and the continued impact of the pandemic. Norges bank also proceeded with a second rate hike this year, despite fresh containment measures being announced by the government.
More importantly, perhaps, the ECB confirmed the widely-held expectation that it will end its Pandemic Emergency Purchase Programme in March. Nonetheless, the ECB is not looking to lean strongly against inflation yet. The revisions to the staff projections were fodder for some hawkish headlines, with the ECB raising its forecast for next year to 3.2%; almost double the previous forecast. However, as President Lagarde explained, two thirds of this revision were due to the expected impact of energy prices. Moreover, the ECB now forecasts inflation at 1.8%, “which is obviously not 2”, and as Lagarde added, “we want to get to that medium term target, in line with our forward guidance.” We would also point out that Lagarde added that these forecasts take into account a relatively high rate of wage growth, even though she stated that the Council still sees very few signs of second round effects. In other words, it seems as though upside risks to the forecast are limited, even if wage developments accelerate somewhat in 2022 – as they have already been baked into the cake.
In other words, the ECB is certainly not looking to rush to the exit as the Bank of England or the Fed are now appearing to do. Indeed, the ECB will increase its ‘regular’ APP purchases in the second and third quarter of the year to mitigate the impact of PEPP ending. Moreover, from October 2022, these purchases are expected to run at €20 billion per month for as long as necessary. Although the ECB failed to push back markets’ expectations of a December 2022 hike, we maintain our view that a rate hike in 2022 or even 2023 is unlikely.
The market’s reaction was perhaps as confusing as the Bank of England’s policy shift. As noted above, money markets suggest that the ECB hasn’t really changed traders’ views of the future path of policy. However, EUR/USD recouped some of its losses after the ECB and its peers seemingly closed some of the policy gap with the Fed’s accelerated timetable for policy tightening. And when it comes to fixed income, the ECB’s announcement was first received as a hawkish signal, sending Bund yields higher and causing Eurozone spreads to widen. However, that move quickly reversed and someone looking at the screens now would believe that the ECB decision was interpreted as neutral to moderately dovish. This once again underscores the new environment we alluded to earlier: the market will have to learn to live with uncertainty about monetary policy again, as central banks –and the ECB in particular– seek to regain some flexibility.
Earlier today, the Bank of Japan followed the others in their assessment of Omicron. Governor Kuroda even explicitly stated that he “has not heard Omicron is changing consumer behaviour” – i.e. the BoJ does not fear an Omicron-related decline in consumption and output. Nonetheless, the Bank did extend its Covid funding programme, which was scheduled to end in March, by 6 months. This is mainly to support SMEs that have fewer cash buffers than larger corporations. Although the BoJ plans a step-wise reduction in purchases of corporate bonds and commercial paper to zero by March, their broader message is still leaning towards the more dovish side. The Bank repeated its commitment to easy policy until its price target is met. This significantly more dovish tone will probably keep the JPY on the back foot against major peers.
Of course, that is nothing compared to the weakness of the TRY to date. The Turkish central bank moved to cut rates once again yesterday, despite –or because of?– soaring inflation in the country. Although the central bank stated that this decision “completed the use of the limited room implied by transitory effects of supply-side factors”, suggesting that this 100bp reduction was the last in the cycle, the lira suffered another sharp sell-off and USD/TRY breached the 16 mark this morning. Given the recent history of Turkish monetary policy, that is not too surprising. The recent unorthodox way of dealing with high inflation has not helped confidence in the institution or currency. And even if policymakers intend to end the easing cycle here, it would certainly not be the first time that Erdogan fires a central bank official for refusing to lower rates.
Fri, 12/17/2021 – 09:53