Thoughts

April 12, 2024 | 14:00

Central Banks: Stick to the Plan... for Now

Economist

Jennifer Lee

Senior Economist and Managing Director
Economics

(Read more)

Jennifer Lee

Senior Economist and Managing Director
Economics

(Read more)

“Now what?”

There is a huge likelihood that the above question was uttered at every central bank after the March U.S. CPI was released. With the market rethinking the Fed’s moves, there are obvious reverberations felt around the world, particularly in the FX market. Even ECB President Lagarde said that while the ECB’s policy is not Fed-dependent, “it matters to us and… all of that finds its way into our projections”.

Of course, this is a new development. Are the other inflation indicators that the Fed watches also sticky? In the meantime, the ECB remains set to lower rates in June. It did not stray far from the forward guidance that it first gave in March. Remember? President Lagarde said there would be only “limited” new information in April, but there will be plenty more come June, including two new CPI reports. Plus, the latest Press Release contained a new line that gave a blindingly obvious hint: “If the Governing Council’s updated assessment of the inflation outlook… were to further increase its confidence that inflation is converging to the target in a sustained manner, it would be appropriate to reduce the current level of monetary policy restriction”. In other words, unless something comes out of left field and knocks all the encouraging data seen of late off its feet, expect a rate cut on June 6.

The BoE meets in May and in June and is dealing with some complications. Yes, inflation has been trending down and wages grew at their slowest pace in 1½ years. The minimum wage increase will hit the data, but the BoE is well aware that the near-10% hike is coming, so it will look through it. The economy is also starting the year with better momentum (real GDP grew in January and February), which suggests last year’s recession was short-lived. And, although there are fewer hawks voting for rate hikes these days, the other hawks are still hawks. Just this week, Megan Greene warned that rate cuts “should still be a way off” given the persistence of inflation pressures. BMO continues to look for a June cut but we only expect two rate cuts this year, instead of three. Every move, however, is data-dependent.

Meantime, the BoJ is in a tight spot, particularly with the JPY cracking the ¥153 level, or a 34-year low. Mixed messages from Governor Ueda were unhelpful (not changing policy because of the currency; but, it is open to less easing). On top of that, the Bank is reportedly going to raise its CPI forecast at the next meeting on April 26. That will likely be the only major change it will make.

Currency Update from Stephen Gallo (Global FX Strategist): The price action in the FX market took a new form this week, akin to a ’22/’23 redux. Global upside inflation risks are rising, and some central banks will be easing policy into that backdrop, while the Fed has the luxury of being able to insulate the U.S. economy from those risks for a while longer. USD’s appreciation also reflects elements of investor re-positioning, and, possibly, reduced market liquidity. There are likely limits on the extent of policy divergence given moderate global recession risks (for now), and limited appetite amongst central banks to ease. The baseline is for EURUSD to find a floor in the $1.05-to-$1.06 range, and for a USDCAD cycle peak in the $1.38-to-$1.40 range (1-3M). However, non-USD currency vulnerabilities to external shocks have clearly increased. FX volatility could well be on the cusp of finding a new, higher floor.