It’s a monster week for central bank policy with some potentially big decisions to be made not only at home in the UK, but most importantly out of the US too.
Bank of England
Let’s start at home, with the growth of Omicron exponential in the UK and authorities clearly worried about the variant’s spread, we expect the Old Lady to remain on hold in December, citing a requirement for additional clarity before they move. However, we expect any guidance to acknowledge the impact of ongoing inflationary pressures and when they do have clarity, they will be ready to move the base rate upwards without hesitation.
The US Fed
In contrast, the US economy is exceptionally strong and if anything is actually now overheating. The Fed is way behind the curve and it may already be too late to avoid boom and bust. Arguably the Fed should have been raising rates by now with tapering of bond purchases firmly in the rear view mirror. Sadly we are not at this point and with Chair Powell retiring the word “transitory” and acknowledging the US has an inflation problem, in the process joining many other central banks on earth by raising rates or preparing to raise rates, the Fed will be playing catch-up. We expect the pace of tapering to accelerate with a chance that purchases could get turned off altogether at this week’s meeting.
European Central Bank
With Chair Powell finally retiring the word transitory it’s really difficult for the ECB to remain the outlier in being the only region on earth to experience transitory inflation. This leaves Madame Lagarde in a bind because Europe still has a big problem with Covid with shutdowns leading to economic weakness. It’s clear the ECB wants to stick to plan and announce an end to the “Pandemic Emergency Purchase Programme (PEPP)”. We think this will be announced at this meeting, effective March, however there’ll be no cliff edge in bond purchases with a post-PEPP programme announced. They will also be keen to stress they have the full toolkit available should they need it given the uncertainty over the current economic outlook.
Watch the Fed! With the USD the world’s reserve currency, the price and availability of USD is all important to how markets will trade in the coming weeks and months. The sticky US inflation outlook and exceptionally strong labour market means the Fed is going to have to attempt to stick to plan and tighten policy even if we see a bout of market weakness.
In addition, we’ve talked about US exceptionalism before (read the blog post here) as being the driver for a stronger USD and outperformance by US assets. Now we are entering a pronounced US tightening cycle, this has further ramifications for economies and markets in the rest of the world. We expect further USD strength as the US tightens and raises rates. This is a particularly poor mix for emerging markets given much of their liabilities are priced in USD, but as USD deposit rates rise, this may well have implications for all risk assets.