Thanks for More Policy Stability

• Over the past week, a dearth of data left policy comments featuring more prominently. Thankfully, policymakers are settling into relatively predictable patterns after violent swings earlier this year. We also raised our UK inflation forecasts amid cost pressures.
• Next week’s release calendar is for us dominated by Euro area inflation, where we are a tenth above the consensus and see upside risks to our 10.5% forecast. A higher outcome may drive the ECB while the Fed watches payrolls and we keep an eye on UK mortgages.

It has been a quiet week on the data front, which left more space for the belated insights on recent Fed and ECB decisions in their minutes. The former reiterated that it might soon be time to slow its hikes, as markets already price. Meanwhile, the ECB unsurprisingly considered a 50bp in October yet overwhelmingly backed the 75bp delivered.

Commentaries from committee members also continued to air differences of opinion rather than signalling a substantive shock to expectations. The ECB has an upside skew to the 50bp hike we and the consensus expect in December, while risks around the Fed appear more balanced. That difference could become more apparent or even crystalise in call changes next week, as two of the pivotal datasets are released – i.e. EA inflation on Wednesday and US payrolls on Friday.

Hawkish comments from Isabel Schnabel at the inaugural BoE watchers conference (a great event) reinforced the ECB’s strategy of taking rates to a tight setting. Bemoaning the unhelpful stimulus from rates falling further out the curve doesn’t change the fact that this is the natural flipside to the “robust control” approach. Indeed, the policy rate pricing for the euro area has bullishly flattened over the past week, knocking 2025 yields about 30bps lower. That has removed the inappropriate upward slope in 2024 while still leaving room for inversion. Other parts of the euro curves have run ahead on this front, with Germany’s 2s10s hitting its steepest inversion in 30yrs.

Despite our modal policy views being for lower terminal rates, we still support this curvaceous repricing (see Curvaceous ECB Policy, 8 November). Markets should price the probability-weighted mean, which necessitates incorporating a significant upside skew to the modal consensus. More persistently high inflation is the most likely trigger for crystalising some of that risk in the mode.

News on the inflation side remains concerning, with surprises consistently skewing higher. We see prices remaining far below where firms would like them, encouraging substantial jumps to close some of that gap and preserve profitability. Unfortunately, additional cost shocks have prevented the UK’s gap from closing at all yet. Government policy now encourages second-round effects that raise the equilibrium price and cost-push inflation towards it over the next 18 months. This macro story raised inflationary trends in our forecast to be almost 2pp above the consensus. That is less than the 4pp gap in March but could still rise again (see UK Costs Pushing More Inflation).

It also doesn’t help that the UK ONS dropped the metaphorical ball by accidentally dropping diesel from its PPI series all year. It has revised up annual headline rates of PPI output price inflation by an average of 1.8pp throughout 2022 (see Producer Price Index correction notice). If only it hadn’t rejigged this release, we’d have kept producing a bottom-up PPI forecast and flagged it sooner.

At least we don’t have bungled data analysis driving our freedom anymore, unlike in China, where speculation of technocratic changes has global spillovers. This week, Alastair Newton highlighted that there was significantly less to China’s recently announced support for the property sector and easing of its zero-covid policies than the market rally suggested. Furthermore, the Biden/Xi Jinping summit will not lead to any easing of the US’s technology embargo. He concludes that investors are right to remain “wary” (see China: Reasons to Be Careful, Part 3).

Stop-start disruption in China doesn’t help the globally integrated manufacturing sector, and news in the Nov-22 PMI surveys reinforced the global trend towards falling activity. The US drop crystallised the convergence risk we flagged last month, while national levels are broadly consistent with Q4 activity declines. That would confirm a technical recession in the UK.

Although there is arguably enough recessionary evidence for global monetary tightening to slow slightly in December, unemployment will need to have definitively turned for hikes to end. So far, unemployment is only showing some signs of deterioration, leaving most of the necessary moves to follow with the usual lags into 2023 (see PMI Consolidation Behind Contractions).

Preview: EA inflation in Nov-22 (Flash)

The Euro area continues to suffer from severe inflationary pressures that are broad across countries and divisions. Surging food prices will likely raise this source’s contribution in November again. However, energy prices may ease, primarily because of falling petrol, diesel and liquid fuel prices. That slows our headline forecast slightly to 10.5%.

Despite being a tenth above the consensus, we see upside risks. There has been a frustratingly substantial and consistent upwards drift in forecasts (see EA: Flash, Bang, Inflation Fanned). Repeating that would yield something nearer 10.8% this month, extending the trend rise. Another painfully high print could quickly push the ECB into a 75bp rate hike instead of our 50bp baseline (see EA: Huge Final HICP Print Trimmed Again).

Figure 1: EA HICP inflation aggregates

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