Doves Over Skis Pricing Spring Cuts
Another disinflationary surprise in the euro area helped fuel dovish pricing, with markets seemingly over their skis betting on spring cuts. We also analysed UK surprises as another lens to our view that the BoE won’t cut rates until 2025.
Next week has a thin calendar of economic data releases, albeit with the final services PMIs. The RBA and BoC are scheduled to announce their policy decisions and will likely continue the global trend for no-change decisions.
Market pricing for the cutting cycle has become more aggressive this week. The Fed and ECB pricing now consider a substantial risk of a first cut in March, with the meeting after that priced as more likely than not lower. Signs of slower consumer price inflation drive the move, aided by any policymaker comments sounding slightly ambiguous about the higher for longer manta. It looks to us like market participants have gotten long over their skis in considering Spring rate cuts.
The EA inflation data were the week’s most prominent data release for us, and not just because they fed the prevailing market narrative by undershooting expectations for the third consecutive month. By falling 49bps to 2.41% in Nov-23, it was 0.3pp under the consensus (only 16bps less than we expected). The downward bias in outcomes since the Oct-22 peak is substantial, even if half of that merely invalidates consistently exaggerated expectations for positive payback.
Nonetheless, base effects from German energy utility support are set to break the EA’s inflationary downtrend in Dec-23. Underlying inflation has slowed to the target recently, but the monthly impulse does not appear to have fallen below it. Achieving the target is a reason to keep rates as they are, with a probable undershoot needed to justify a loosening. So, we still believe ECB rate cuts will wait until 3Q24 (see EA: Inflation Slumps Into Trough).
Dovish discussions seem most at odds with the uncomfortable realities in the UK, where the BoE’s medium-term inflation forecasts have been grinding higher amid evidence of persistence from wages. Its historical errors have clustered in regimes lasting several years. Inflation has at least cleared a low hurdle and proved more predictable in 2023, with spot surprises no longer skewed so heavily. Still, the trend appears to have exceeded expectations, and we expect a 2024-25 repeat. Wage settlements are too high and reinforced by myopic government policy before the election. In our view, second-round effects still delay rate cuts to 2025 (see UK Trend Inflation Problem).
The Reserve Bank of Australia and the Bank of Canada are the next central banks to announce their policy decisions on Wednesday and Thursday. Both are expected to keep policy on hold after the unsurprising announcements for a 25bp rate hike from the RBA on 7 November (see here) and the BoC for no change on 25 October (see here). No-change has also been the order of the past week, with policy in Korea, New Zealand and Thailand all following suit.
The Bank of Korea’s decision to maintain its policy rate at 3.5% reflected the complexities of navigating high inflation trends amidst global economic uncertainties and domestic resilience. It shows a cautious inflation-targeting approach weighing global monetary tightening and geopolitical risks against domestic factors like export growth and housing loan market dynamics.
Similarly, the Reserve Bank of New Zealand’s decision to keep the Official Cash Rate at 5.50% reflects a measured response to the amalgamation of domestic resilience, a global economic slowdown, and persistent inflationary pressures. The Bank's policy trajectory seems to pivot on a delicate balance between potential domestic demand strength, which could heighten inflationary pressures, and the global economic slowdown that might counterbalance these pressures. This underscores the bank's commitment to a continued restrictive monetary policy to manage these competing forces.
In contrast, the Bank of Thailand's unanimous decision to hold the Policy Rate at 2.5% underscores a more cautious approach, aiming to balance economic recovery with inflation control. The decision was influenced by mixed domestic and global economic factors, including domestic demand, tourism, merchandise exports, global energy prices, and El Ni?o-related food price increases. This approach symbolises a broader strategy to sustain long-term growth and financial stability.
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There were plenty of speeches from policymakers again, albeit most were not that interesting. In the UK, Megan Greene's inaugural speech focussed on the medium-term outlook, inflation targets, and the challenges of supply shocks for monetary policy-making (notes here). Jonathan Haskel's analysis of UK inflation and its prospects highlighted the role of labour market tightness in persistent inflation (notes here).
BoE Governor Andrew Bailey and ECB President Christine Lagarde focussed on other things at topical events. Bailey seems frustratingly fond of going off-piste, with his latest discourse on the evolution of the foreign exchange market over the past 50 years touching upon the role of currencies, market participants, and the need for effective risk management (notes here). Amid all his communication fumbles, Bailey might like to consider that when he can’t even think of a title for his speech, he may not have a message worthy of delivering. The AI doesn’t get bored parsing such things (notes here), but it's nice when the speech is worth reading.
Meanwhile, President Christine Lagarde focussed on the Single Supervisory Mechanism to underscore the critical role of unified supervision in ensuring effective monetary policy transmission and a robust banking system. Her observations on the impact of a weak banking system on policy rates are particularly noteworthy (notes here). The praise for European banking supervision in fostering sound banks and addressing common challenges like climate risks also featured prominently in the typical posturing speech-filler.
The tiresome political posturing comes unusually close to (my) home for a few days as delegates flock to Dubai for COP28. Attendance may be almost double the previous COP record as the world descends to enjoy the sunshine and shopping here. And the abnormally high number of helicopters buzzing overhead suggests they love those regular descents. I suppose we can’t expect hypocritical attendees to travel to a climate confab using the quality metro or even get driven down the main Sheikh Zayed Road through Dubai, which closes especially for them in the mornings.
On a more serious note, Alastair Newton previewed how, despite some positive signs from China and the US, the world’s two biggest emitters, and determined conference chairing by the UAE, expectations for COP28 are rightly low. The onus to do better rests primarily on the financially stretched and distracted developed world (see Good COP, Bad COP). Nonetheless, the UAE Chair has chalked up a win with a first-day agreement on a climate fund, albeit unavoidably skinny in size.
Forgive me if I avoid the remaining climate events at the Expo Centre in favour of sunshine around UAE national day, starting with the fittingly named Terra Solis tomorrow. Yawm Watani Saeed!