Policy remains very accommodative despite high nominal growth
Yesterday, several central banks including the Bank of England and the ECB met for their last meeting of the year. For most of them, accelerating inflation has placed political normalization high on their agenda. The BoE has taken a qualitative step forward. With the asset purchase program complete, Bailey an Co immediately moved on to the next phase, raising the policy rate by 15 basis points to 0.25%. While the impact of the end of the leave scheme was still a concern at the November meeting, the persistence of strong employment data and inflation accelerating above 5% this time forced the BoE to prioritize inflation. The Bank did not give clear indications on the timing of the further increases. However, with inflation expected to stay at current levels or higher until April, follow-up action could already take place in the spring or earlier. UK yields initially jumped as high as 9bp, but the gains evaporated in a broader risk aversion movement. The initial gains of the pound sterling (against the euro) also reversed following the announcement of the ECB’s policy. EUR / GBP closed at 0.8505, little change from Thursday (0.8515). The ECB presented the policy roadmap as net purchases of PEPP will stop at the end of March 2022. However, Lagarde and Co have performed a recalibration, rather than a qualitative step towards a deep normalization of the policy. PEPP reinvestments will even be extended at least until the end of 2024. Net purchases of PEPP in the first quarter of next year will slow down from the current pace. To ensure a smooth transition after PEPP, APP purchases will increase to 40 billion euros per month in the second quarter to be reduced to 20 billion euros in the fourth quarter. Omicron / the development of the pandemic remains a key source of uncertainty and the ECB still sees the need for continued political accommodation. Growth is expected to remain strong (5.1% 2021; 4.2% 2020; 2.9% 2023). Inflation has been revised up to 2.6% this year, 3.2% next year, but is expected to fall below the target (1.8%) in 2023 and 2024. The ECB will assess the policy measures on a quarterly basis, but Lagarde reiterated that rate hikes in 2022 are unlikely. Yesterday’s ECB action is subject to differing interpretations. Policy remains very accommodative despite high nominal growth. At the same time, some market players will see this as a potential opening to (accelerated?) Policy normalization next year. German yields initially jumped more than 5 basis points, but also failed to resist a worsening of the US risk correction (Dow -0.8%; Nasdaq -2.47%). German rates closed between -0.1 bps (2 years) and +4.1 bps (30 years). US rates fell between 8.1bp (5 years) and 0.75bp (30 years). For both the German and American 10-year rate, the technical picture remains fragile. The first struggled to regain -0.35%. The US 10-year rate is likely to fall below 1.41% support. A break would bring this month’s low (1.33%) onto the radar.
On FX, the ‘ECB roadmap’ triggered EUR / USD to contract with the pair hitting the 1.136 area. Momentum eased quickly, but the sharp decline in US yields weighed on the dollar and allowed EUR / USD to close well north of 1.13 (1.1330). The EUR / USD created a bit of a breather on the 1.1186 / 1.1222 support area, but only a sustained breakout above 1.1385 would signal that the single currency may enter calmer waters. The trade-weighted dollar (DXY 95.94) is trading recent highs. For this index, 95.51 is the first important benchmark on the charts.
The Bank of Japan kept its key rate at -0.10% and the 10-year yield target at 0%. He cut some of his stimulus measures. The quota for additional purchases of corporate bonds introduced after the pandemic will end in March of next year. From now on, business assets in circulation will gradually be reduced to around half of today’s $ 11 billion. Its emergency financing plan offering loan support ends as planned in March 2022 for large companies but has been extended by six months for SMEs. Support for monetary policy is still very generous as inflation remains subdued while the omicron poses new threats. The Japanese yen is trading little changed near USD / JPY 113.5.
Mexico’s central bank raised its key rate by 50 basis points to 5.5% yesterday. The larger-than-expected rise was justified by increased inflation expectations and upside risks, as well as the shift of other central banks (including the Fed) to a faster pace of tightening. The central bank predicts that prices will rise to a record 7.1% in the fourth quarter of this year and only relax near the 3% target in 2023. Officials have left the door open for more further increases, most likely in 50 basis point clips. The Mexican peso strengthened yesterday, sending the USD / MXN below 21.