Thoughts

January 26, 2024 | 14:30

Knowing When to Hold and When to Fold

Economist

Jennifer Lee

Senior Economist and Managing Director
Economics

Jennifer has been wi... (Read more)

Jennifer Lee

Senior Economist and Managing Director
Economics

Jennifer has been wi... (Read more)

“It does not matter how slowly you go as long as you do not stop…”

That particular Confucius saying comes to mind, but we take issue with it in this case. The act of central banks pausing for too long, or keeping rates too high for too long, matters. On that note, the BoJ stunned absolutely no one this week when it announced that it will continue on with its QQE with YCC program. Governor Ueda dropped hints, again, of tweaks coming at some point, but this central bank has cried wolf often. However, the Minutes from its December meeting showed that this time, it may be different. Members recognized it was “important to… deepen discussions on issues such as the timing of the exit… and the appropriate time of raising… rates thereafter.” Of course, the dramatic drop in Tokyo CPI didn’t help that case, but we may see some tightening coming, perhaps by June.

The ECB, meantime, kept rates steady as well this week. President Lagarde attempted to be as neutral as possible on the timing of the first rate cut but did not downplay the possibility of April. We have previously shrugged off that possibility, given that 1) there won’t be any new staff forecasts to refer to and 2) it takes time for new wage settlements to filter through the economy. However, we now know that the ECB has access to more real-time wage data (a “wage tracker”), and that so far, it is seeing a slight decline in wage growth, which supports an earlier cut. Then, the unnamed sources who spoke up after the press conference revealed that there was a willingness to start discussing rate cuts during the March meeting, but only if it was clear that inflation would hit 2% this year. Hawks on Friday, not surprisingly, called for patience. One does wonder what the hawkish Joachim Nagel’s true views currently are on rate cuts when the Bundesbank warned that Germany’s economy would “stagnate, at best” in Q1 and that would “delay the recovery”. The current train drivers’ strike, the longest in at least 30 years, doesn’t help either.

Next week, keep an eye on the Euro Area’s preliminary January CPI, as well as first quarter real GDP. Inflation is expected to retrace some of December’s run-up, and a larger move would add to the earlier cut theme. Same as a negative Q1 GDP read, which could mean a technical recession. In any event, we remain comfortable with our call for June as enough time would have elapsed to get a sense of the impact of the wage settlements on the broader economy.

Now, the spotlight turns to the BoE on February 1. Again, look for its policy rate to remain at a 16-year high of 5.25%. Perhaps the most intriguing takeaway will be the vote itself. We all know that most central banks have lively debates over the direction of policy—especially these days—but the BoE is one of the few banks that actually reveals how each policymaker voted. For the last two meetings, six members of the BoE voted to keep rates unchanged, while the remaining three stayed true to their hawkish colours and voted to raise rates 25 bps. However, the Minutes showed that “most” of the six felt it was “too early to conclude” that services CPI and wage growth were “on a firmly downward path”.

That should change at the next meeting as there has been “brand new information!” (insert Phoebe Buffay’s voice). Real GDP contracted in the three months to November, while retail sales slumped, and wage growth slowed sharply. Jobless claims rose, and the number of job vacancies fell. All push for lower rates. However, the latest inflation data are an added wrinkle. Headline inflation perked up in December to 4.0%, from November’s 26-month low, but that was expected. However, core CPI was unchanged, and services inflation accelerated. And, the Red Sea attacks pose a threat to supplies and deliveries, which means higher prices. Assuming these attacks have a shelf life, then the BoE should look past this.

On net, the new information should be enough to prompt a rate cut as early as May, when the next round of new forecasts are released. It will spark a healthy debate and perhaps unseat one or two hawks, nudging them over to the other side…