October 28, 2022 | 15:50
No Treats in Monetary Policy, Just Tricks
It was quite the week in central banking…
The ECB’s 75 bp rate hike met market expectations and was the third increase in a row for all three key rates (deposit facility, marginal lending facility, main refinancing operation), totalling 200 bps (July +50 bps, September +75 bps, October +75 bps) but the decision did not come easily. It was disappointing to not hear President Lagarde repeat those shockingly specific plans that she laid out in September. (It will take “several meetings” to get to the 2% target, and several meant “probably more than two, including this one, but it’s probably also going to be less than five”.) Naturally, the press was all over the fact that the October statement did not contain such specifics as the word “several”. The usual sources who pipe up after the meeting revealed that the hawks on the Governing Council didn’t think that it was a big deal, while the doves seized on it, believing that it was a signal that tightening could end as soon as December, or in March. The ECB head casually shrugged off the missing word, stating the obvious: decisions are data-dependent, and will be made on a meeting by meeting basis but “there is still ground to cover”. Plus, they “may well have to go beyond” this path of normalization. Note that we continue to see the ECB raising rates to as high as 3% next year.
A handful of GC members chimed in on Friday morning, mostly from the hawkish camp, all pointing to further increases although France’s Villeroy de Galhau warned that another 75 bp hike was not a given. “We’re not subscribed to what one calls jumbo increases.”
In any event, continued hikes are the ECB’s plan, at least for now. And although a technical recession has been avoided so far, President Lagarde sounded resigned to it, as she mused about the “higher likelihood of a recession”, and “the probability of it having increased”.
On October 31, the broader Euro Area Q3 real GDP report will be released, and it is expected to be weak but, surprisingly, still not negative. That would be a treat. The two largest economies managed to grow, albeit modestly. German real GDP actually picked up for the third quarter in a row, up 0.3% q/q or 1.2% above year-ago levels. (There is some skepticism given that the composite PMI has been sub-50 for four months in a row, and that a number of firms have stopped producing completely given high energy costs… hence, gas storage levels at around 90%. And, there was big revision this summer… when the negative Q2 result was revised to a positive.) France’s real GDP also grew 0.2% q/q or 1.0% y/y in Q3. Add Spain to the mix, too. Other countries were not so lucky: Austria, Belgium and Latvia shrank in the third quarter.
Markets will, however, get a big trick: Euro Area October CPI, also out Monday morning. Judging from what we’ve seen so far, one better be sitting down for this. Germany’s inflation rate climbed to 11.6% y/y, France is at 7.1%, and Italy surged 12.8%. These are rates that are high enough to justify a heated debate within the ECB on what to do next.
The Bank of Japan wrapped up a busy week for central banks and decided to take it easy on us by doing exactly what was expected. Nothing. The vote to maintain yield curve control (short-term rates at -0.1%, keep 10-year JGB yields at around 0%) was unanimous; and, to keep buying ETFs, J-REITs, CP and corporate bonds. And, that the Bank will run with its Quantitative and Qualitative Monetary Easing (QQE) with YCC for “as long as necessary” to get to the 2% price stability target. The Statement on Monetary Policy was oddly shorter than usual but there was a good reason. The vote to maintain its policies was unanimous for the second meeting in a row; usually, it was a vote of 8-to-1, and there would be the customary footnote about who was for and who was against. And usually, it was the ultra-dove, Mr. Kataoka Goushi, who dissented, but he left the BoJ in July.
So that covers it for the ECB and the BoJ. They may not have all the information they desire but at least they had something to work from. Next week, the Bank of England will make its announcement on Thursday and unfortunately, in the words of Governor Andrew Bailey, the MPC will be “flying blind”. They have no (or very little) idea of what PM Sunak and Chancellor Hunt have in store for the country… in terms of their medium-term plans to rein in its finances. Rest assured, whatever we heard from the former administration has been tossed out the window. But everyone is bracing for the November 17th Autumn Statement to contain spending cuts and tax hikes to fill the approximate £40 bln fiscal hole (estimates range from £30 bln to £50 bln), which will, in turn, further slow the U.K. economy. As the new leader put it, “difficult decisions” will be made, one of which is the pensions triple lock. It states that pensioners’ payments would rise by the highest rate between: 1) inflation; 2) average earnings; or, 3) 2.5%. I’m going to take a wild guess and say that Door #1 (inflation) currently has the highest rate. Although PM Sunak has said he will always “protect the most vulnerable”, well, he needs to cut costs and that is one area to cut. (FM Hunt could be creative, though.) The on-again/off-again corporate tax hike (from 19% to 25%) is likely going to be on again and will take effect in April 2023. (This was then-Chancellor Sunak’s plan back in the day.) Of course, the PM needs to give the people some hope for better days ahead. Although income tax cuts will likely not be introduced until inflation comes down, Rishi Sunak may go back to some of the ideas he tabled over the summer when he was running for this job. One of those ideas included lowering income taxes by one percentage point in April 2024. And, a 25% energy profits levy may once again see the light of day.
What we know is that the current U.K. inflation rate of 10.1% is the highest in four decades, and the 6.5% core CPI rate is the highest in three decades. That’s miles from the 2% target and clearly, the BoE is not meeting its mandate of price stability. Something needs to be done to bring inflation to its knees and that something is rate hikes. While there is no longer an urgent need for a full 100 bp increase, the still-low value of the GBP and the high inflation rate points to, in our opinion, a 75 bp hike. However, the risk lies in a 50 bp’er given that the majority of the BoE typically votes for the more modest-sized increase.