Last week, we saw Bank of England (BoE) officials try to cool market expectations with regards to the path of interest rates. Right now, markets are priced for UK Bank Rate to end 2022 at 2%, a total of 175 basis points of hikes this year. The BoE Chief Economist Pill stated that policymakers should raise interest rates gradually rather than taking an “aggressive” activist approach. In addition, Pill hinted that the market is overestimating the scale of monetary tightening the BoE was likely to deliver over the next year.
In the meantime, the UK GDP numbers released showed growth at the quickest annual pace since WW2. The British economy grew 7.5% in 2021, official figures revealed Friday, rebounding from its historic 9.4% plunge in 2020. On a quarterly basis, the flash reading is estimated to have increased by 1% in the final three months of the year, down slightly against forecast whilst the monthly figure showed that economic activity for December contracted but not as fast as predicted given Omicron.
Looking to the week ahead, the market will focus on data for further clues on the pace of the interest rate hiking cycle. This week’s data releases include the Labour Market data (Tue), CPI Inflation (Wed) and Retail Sales (Fri). The headline CPI inflation surprised to the upside for a third straight month in December rising to 5.4% but is expected to hold firm for January. However, with the regulated energy prices set to increase by more than 50% in April, this is expected to rise in subsequent months. The BoE sees a peak at 7.25% in April before falling back below the 2% target by 2024. Whilst inflation is the driver behind monetary policy the market will be mindful of the unintended effects on consumer spending and labour markets. The market will keep a close eye on these metrics to decipher future trends.
Can Eurozone Inflation Really Get Back to 2%?
European Central Bank (ECB) officials tried to play down the prospect of aggressive rate hikes in 2022. ECB President Christine Lagarde echoed a similar tone to BoE Chief Economist Pill, stating she favoured ‘gradual’ policy adjustments. In addition, two ECB members, de Cos and Villeroy followed a slightly more dovish rhetoric. Council Member de Cos commented that despite current inflation data showing an upward trajectory that the medium-term outlook remains that price pressure will subside back to the bank’s 2% target. He also commented that any future potential monetary policy tightening will be gradual. However, President of the Deutsche Bundesbank, Joachim Nagel, commented that he would support a normalisation of monetary policy should the inflation outlook not change by March. Adding to the hawkish rhetoric, he commented that acting too late will have significantly higher costs than adjusting policy too early adding to the pressure on ECB policymakers ahead of the March meeting.
Looking to the week ahead, President Lagarde (Mon) and Chief Economist Philip Lane (Thu) are among ECB officials scheduled to speak. Lane’s comments could be particularly interesting as he may defend the ECB’s inflation forecasts amid unconfirmed reports that some policymakers are losing faith in the projections. In terms of economic data, the ZEW economic sentiment is due for release on Tuesday. The ZEW survey is based on a survey from institutional investors and analysts which looks at the current and forward-looking (6 months) sentiment.
FOMC Minutes Could Shine Light on The Path of Policy Action
It was a relatively quiet week in terms of economic data as the market continued to digest the positive labour data from the previous week. Last week we saw inflation posting a 40-year high as the consumer price index touched 7.5% which continues to keep interest rate policy front and centre of the market agenda. A further rise in US CPI close to 8% seems likely next month, partly reflecting further upward pressures from energy prices. As a result of the inflation outlook, US 10-year Treasury yields rose above 2% for the first time since the start of the pandemic. This can be used as a broad indication that the pace of rate hikes may accelerate.
Looking to the week ahead US data include Producer Prices (Tue), Retail Sales (Wed) and Industrial Production (Wed), however, with a hike fully priced in for next month it is unlikely that these releases will change sentiment. The minutes of the last Federal Reserve (Fed) meeting will also be released on Wednesday, which might shed more light on the possibility of a larger March hike and prospects for balance sheet reduction. The market will decipher these minutes for clues on the path of future policy.
Tensions have been escalating between Russia and Ukraine for some time now with hopes of diplomacy fading. This is evident as Western nations have begun the withdrawal of diplomatic and military personnel. US intelligence assessments estimate that Russia could launch a full-scale invasion in the coming days as there are more than 130,000 troops on the boarder. However, the White House believes that Putin hasn’t made a final decision on this yet. If we do see a full-scale invasion, it is likely that we will see an injection of uncertainty into the financial markets with the US Dollar likely to benefit due to safe haven flows. In retaliation to sanctions, Russia may reduce the flow of fossil fuels to the West which could further impact inflation.
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