At a difficult juncture, with economic recoveries having slowed and now facing risks from even higher inflation linked to the spillover effects from the Ukraine war, policy normalisation from central banks (if it hasn't already) is starting to take shape. Both the RBA and ECB now have 2022 rate hikes as a possibility while the Fed is set to start hiking next week.
RBA Governor Lowe said hiking rates in 2022 was plausible...
At this week's AFR Business Summit, RBA Governor Philip Lowe said it was "plausible" the cash rate would need to rise this year. However, uncertainty around the evolution of wage and price pressures after years of inflation coming in below the 2-3% target meant that the Board remains in a patient mode for now, well behind the aggressive series of hikes being priced by markets. Governor Lowe said the greater risk to the economy (and to the achievement of its broader mandate) was moving pre-emptively in hiking rates, which would slow progress towards full employment. But it was highlighted that low and stable inflation is a precondition to sustaining low unemployment, meaning that the RBA needs to keep its options open in 2022.
The two developments being closely followed by the RBA regarding the inflation outlook are the spillover effects from higher commodity prices and specifically on the domestic front, the response of wages growth to a tightening labour market. Governor Lowe said the former risked prolonging high inflation that would need to be countered by central banks having to act more aggressively with rates. On the domestic labour market, the Governor noted the official measure of aggregate wages growth was consistent with the Bank's own liaison program in reporting wage increases of around "2-point-something" for the bulk of workers. Overall, the accumulation of evidence is not yet at a stage where labour costs are consistent with inflation holding between 2-3%.
ECB was more hawkish than expected at this week's meeting...
Faced with downside risks to the growth outlook and upside risks to inflation alongside the Ukarine war, the firm impression left by the ECB at this week's meeting was that the latter is driving policy. Despite the uncertainties in the current environment, the announcement of a more accelerated withdrawal of bond-buying was handed down by the Governing Council.
Consistent with earlier guidance, it was confirmed that new purchases under the pandemic program (PEPP) will be be terminated by the end of the month. Purchases will then rotate to the APP program, but over a shorter timeframe than under its previous plan. APP purchases will reduce from €40bn to €20bn over Q2 and, if supported by the inflation data, will be brought to an end in Q3. Earlier, the ECB's plan was for a pace of €40bn/mth in Q2, easing to €30bn/mth in Q3, and then moving to open-ended purchases of €20bn/mth from October. While there was a change in wording, the sequencing of policy normilsation is still intact, with rate hikes to occur "some time after" APP purchases have ended and at a "gradual" pace.
In the post-meeting press conference, ECB President Christine Lagarde said the basis for the recalibrated plan was to give the Governing Council maximum optionality with policy settings given the highly uncertain outlook. Reflecting the headwinds from the Ukraine war from higher energy prices and supply disruptions, ECB staff cut forecast GDP growth from 4.2% to 3.7% this year in the revised set of macroeconomic projections published this week. At the same time, forecast headline inflation was revised sharply higher to 5.1% from 3.2% in 2022, before easing back either side of the 2% target in 2023 (2.1%) and 2024 (1.9%).
An FT report summed up the shift that has come across the Governing Council, with one source who attended the meeting quoted as saying: "The argument about inflation dominated and prevailed over anything else, including the war, the uncertainty and the fears about growth".
Fed to hike next week as US inflation continues to rise...
Another strong inflation print in the US will see the Federal Reserve commencing its hiking cycle at next week's meeting, despite the uncertainty prevailing around the Ukraine war. Headline CPI lifted to 7.9%Y/Y in February from 7.5% while the core rate advanced from 6% to 6.4%Y/Y, both at 40-year highs and in line with expectations.
Energy prices (3.5%m/m) were a key driver of inflation in the month and are set to remain an upward source of pressure with petrol prices rising sharply due to the supply disruptions associated with the Ukraine war. The economic recovery signaled the start of very strong goods demand and, coming at a time of constrained supply chains, higher prices have followed. CPI on durable goods was up 18.7% over the year to February. Although services inflation (excluding energy) is vastly slower at 4.4%, the pace has accelerated over recent months and is now at its fastest since 1991. Also gathering pace has been the housing components; a critical development as they account for around one-third of the CPI. Shelter costs overall were up 0.5%m/m to 4.7%Y/Y, with owners' equivalent rent (around 25% of the CPI) at a 15-year high at 4.3%Y/Y.
