Interest Rate Talk Dominates

FED TAPERING EXPECTED BEFORE YEAR-END

Concerns about China’s property sector and the potential ramifications for the wider economy and the rest of the world exercised investors this week, although those were soothed by liquidity injections by China’s central bank. Meanwhile, the world’s major central banks are grappling with the simultaneous slowdown in economic growth, as evidenced by the latest September PMIs, and the risk that high inflation may persist for longer than expected. This week’s OECD forecast updates, which saw modest downgrades to growth expectations but upgrades to inflation predictions, illustrate this. The European Central Bank has already said it will slow its asset purchases in the rest of the year, while the US Federal Reserve this week announced that a tapering of its $120bn monthly asset purchases “may soon be warranted”, and is likely to start before the year-end. Fed policymakers are also now evenly split between whether interest rates will start to rise in 2022 or 2023 (previously a majority signalled 2023).

MARKETS SEE UK HIKE IN EARLY 2022

In the UK, the Bank of England left policy settings unchanged, including Bank Rate at 0.1%, but an additional MPC member (Ramsden) unexpectedly joined Saunders in voting for an early end to QE. While a 7-2 majority favoured completing the current £895bn bond-buying programme this year, Ramsden’s switch is another indication of the gradual shift in policy signals. The MPC minutes revealed that the BoE now expects inflation to peak above 4% (rather than at 4%) and, moreover, they noted that the sharp rise in wholesale gas prices now risks keeping inflation above 4% into Q2 2022. Financial markets have brought forward a 15bps hike to 0.25% to February 2022 (previously May), with a further 25bps rise to 0.5% priced for August (previously end-2022). They also expect a US rate rise in late 2022. In the meantime, Norway’s central bank this week raised interest rates by 25bps to 0.25%. In contrast, despite the ECB’s intention to ‘moderately’ slow the pace of bond purchases, markets expect no Eurozone interest rate rise until 2024.

SINGING FROM THE SAME HYMN SHEET?

A chorus of central bank speakers next week will doubtless expand upon recent policy deliberations. One of the highlights is the appearance of the US, Eurozone, Japanese and UK central bank heads (Wed) at an ECB event. BoE Governor Bailey will also speak at an event on Monday, while new MPC member Catherine Mann speaks on a panel (Tue). In addition, ECB President Lagarde appears in the European Parliament (Mon). The predominant view remains that price pressures will ease back next year as economies adjust to current supply-side issues such as raw material and staff shortages, but they will be mindful of increasing risks that inflation stays elevated for longer. Fed Chair Powell and US Treasury Secretary Yellen will also testify to the Senate (Tue) and House (Thu), as lawmakers work to reach a deal to extend government funding and avoid a shutdown.

EUROZONE INFLATION TO EXCEED 3%

The Eurozone joined the high-inflation club last month, with headline CPI gapping up to a decade high of 3%. We think it will rise a little further in the coming months, including an increase to 3.3% for September (Fri), which would suggest that short term inflation will be higher than the ECB predicted only recently. Its central view is still very much that this year’s high inflation rates are transitory and medium-term inflation is forecast to undershoot the 2% target. The risk, though, is that it may take longer for inflation to return to 2% than currently expected (Q2 2022). There will be attention also on this weekend’s German federal elections. It looks to be a very close contest as to which party will get the largest share of the vote. Recent polls suggest that the left-of-center SPD’s lead over outgoing Chancellor Merkel’s CDU/CSU appears to be narrowing. At any rate, there will likely be weeks of negotiations to form a coalition government, given fragmented voting intentions, with speculation about various potential, mostly three-way, alliances. A key focus will be whether the next German government will be led by the SPD’s Scholz or the CDU/CSU’s Laschet, and that could have implications for fiscal policy as well as the country’s EU and foreign policy.

US INFLATION REMAINS ELEVATED

There will also be focus on the Fed’s preferred inflation gauge, the PCE deflator (Fri) for August, which will be released alongside personal spending and income. The CPI outturn for the same month provided tentative signs that some of factors that have driven inflation higher this year, such as used car prices, may have started to ease back. Still, annual inflation rates are likely to stay elevated for some time, and policymakers will be watching very closely for signs of any broadening of upward price pressures. We expect the PCE deflator to remain at 4.2%y/y and the core measure to stay at 3.6%y/y. The near-term outlook for US consumer spending remains hotly debated. Personal spending figures have recently held up better than the more narrowly focused retail sales figures, suggesting that consumers are rotating spending from goods towards services. For August, we expect it to be up 0.8%m/m. There will also attention on the timelier gauges of consumer confidence. The preliminary September reading of the University of Michigan’s consumer sentiment index showed only a marginal recovery from the sharp fall in August. There will be an update of the alternative Conference Board consumer confidence measure (Tue). For a broader assessment of current US activity, markets will also take note of other monthly data releases, including durable goods orders (Mon), the goods trade balance (Tue) and construction spending (Fri). The ISM manufacturing survey (Fri) will also be perused closely for early indications of the pace of growth in the sector and whether the index for business prices, while still very high by historical standards, will continue to edge lower.

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