As was widely anticipated, the European Central Bank left all of its monetary policy settings unchanged at this week's meeting. The sense was that this meeting was largely bridging time until the northern summer, by which stage the vaccination rollout is expected to enable the economy to be reopened gradually. In the meantime, ECB President Christine Lagarde said that conditions remained constrained by shutdowns with GDP growth likely contracting over the first quarter. The upshot is that the Governing Council sees the near-term outlook for the economy being weighed by uncertainty and largely dependent on the health situation, though it remains more confident in prospects for the second half of the year with activity expected to rebound at pace as restrictions are phased out. The contrast here has led to some tension, with a few ECB officials in recent times raising the possibility that its bond-buying could be scaled back in anticipation of improved economic conditions, but a Reuters report quoting sources with knowledge of the matter indicated that the Governing Council agreed prior to this meeting that it would not discuss policy implications for June onwards. In the post-meeting press conference, President Lagarde emphasised that any talk of tapering at the highest level of the ECB was premature and would ultimately be guided by the next set of staff macroeconomic projections, which will be available for discussion at its next meeting in June. Tapering is also premature in the context of the Governing Council's decision only last month where it agreed that bond-buying under its €1,850bn Pandemic Emergency Purchase Programme (PEPP) be ramped up at a "significantly higher pace than during the first months of this year". However, gauging the extent of the follow-through on that announcement has been difficult for markets to assess and commentary around this matter was left vague. But for the ECB "preserving favourable financing conditions" is the objective and the Governing Council assesses that it has made progress here since deciding to lift the pace of PEPP purchases in March.
In the US, it was an unusually quiet week in terms of headline events; the main development for markets being reports of the Biden Administration considering a proposal to increase capital gains tax for wealthy Americans. North of the border, the Bank of Canada (BoC) was in the headlines after it withdrew some of its policy accommodation by lowering the weekly pace of its bond purchases from $4bn to $3bn. This was a widely expected move and was justified as being "consistent with the progress toward economic recovery we have already seen". In response, speculation has been mounting as to which central bank might be next in the process of gradually making policy less accommodative, though there are a couple of factors worth highlighting for the BoC. Firstly, at the onset of the pandemic, the Governing Council had more scope to cut rates than other central banks and in response it lowered its benchmark rate by a total of 150bps. Secondly, by comparison, the BoC has made far larger government bond purchases since the crisis than many of its global peers; it now owns around 42% of total government bonds outstanding, which is much higher than is the case for the Federal Reserve and ECB. Furthermore, in line with the updated forecasts in the BoC's April Monetary Policy Report, the output gap in the domestic economy is now expected to close in the second half of 2022, brought forward from 2023, leading to the prospect of rate hikes next year to come across the radar screen for markets.
Switching to the domestic scene, the minutes of the Reserve Bank of Australia's meeting held at the beginning of the month reaffirmed the Board's commitment to its patient stance on policy, expecting that a return to tight labour market, consistent with generating wages growth to sustainably hold inflation within the target band, would not occur "until 2024 at the earliest". The Board acknowledged that markets hold a more optimistic view by noting that 50 basis points of rate hikes are factored into pricing by the end of 2023, but it is wary of the years prior to the pandemic where wages growth was slow and inflation ran consistently below the target. On bond-buying, with the QE program now into its second $100bn tranche, the Board notes that it is prepared to announce further extensions to provide more stimulus to the recovery effort. Domestically, the key point of uncertainty in the economy is how businesses and households adjust to the recent withdrawal of key fiscal support measures, with the sustainability of the rebound in activity hinging on the extent to which accumulated savings are drawn down to fund spending. An example of this caution may have been evident in March's preliminary estimate of retail sales, which despite rebounding by 1.4% in the month were left broadly flat (-0.1%) over the quarter (see chart of the week), though this could also be a sign of spending rebalancing towards services areas in which opportunities to spend are now more widely available than over the past year. Adding to the noise, the annual pace decelerated from 9.1% to 2.3% on base effects, though it will snap back sharply next month. The strength of the recovery to date was underlined by Australia's flash PMI reading for April lifting from a reading of 55.5 to 58.8, indicating a record pace of expansion in the month (albeit the series only dates back to 2016). Encouragingly, activity in both the services and manufacturing sectors advanced at their fastest rates in the survey's history, with conditions strengthening on the back of earlier stimulus and fewer restrictions, consistent with what was reported in the more widely followed NAB Business Survey last week.
Chart of the week
