A holiday-shortened week in the US and limited data kept markets fairly quiet in recent days. In terms of news flow, support for a slowing in the pace of Fed rate hikes, the return of lockdowns in China, and a hawkish RBNZ stood out. In the markets, the rally in bonds continued, which kept the correction lower in the US dollar going. Upbeat risk sentiment sees equity markets well above their recent lows.
Fed downshift on the way
The minutes from the November meeting of the Fed's policy-setting FOMC provided support for a slowing in the pace of rate hikes in the US. The Committee has hiked rates by 375bps so far this year, the past 4 hikes coming at the peak pace of 75bps. The view amongst a "substantial majority" of members was that a slowing in the pace of hikes is likely to "soon be appropriate", with officials increasingly mindful that the full effects of such a rapid tightening cycle are yet to impact the economy.
But a more important message was conveyed by "various participants" that with inflation yet to come under control, rates would need to be raised to a "somewhat higher" level than previously thought. Ahead of the mid-December meeting, two key data points are coming up in nonfarm payrolls for November (due 2/12) and the CPI report also for November (13/12). Those two reports could yet prove the decisive factor but at this stage, a slowing to a 50bps hike looks likely.
RBA Governor flags a regime change in inflation
A quiet week domestically left the focus on a keynote speech from RBA Governor Philip Lowe at the CEDA Annual Dinner. On current policy actions, the governor reiterated that the Board expected further rates hikes would be required to lower inflation to the 2-3% target, leaving its options open on the pace of tightening; though, at the same time he acknowledged it could leave rates on hold.
The central theme in the address focused on the path of inflation well beyond the immediate challenges. Here, Govenor Lowe flagged a regime change from the period of low and stable inflation that characterised much of the period since the early 1990s. Due to structural changes occurring in economies relating to deglobalisation, demographics, climate and the transition to renewable forms of energy, the governor anticipates supply shocks are likely to be more frequent and cause inflation to be more volatile. Governor Lowe said the current monetary policy framework would still be fit for purpose in that environment, but central banks are likely to be setting policy with the growth and inflation sides of their mandates more often in tension - as is the case now.
ECB set for a finely balanced meeting in December
The account of the ECB's October meeting noted "a large majority" of the Governing Council supported the decision to hike rates by 75bps to remove accommodative policy settings in light of risks for high inflation to become more sustained than expected. Next month, the Council will recalibrate policy to revised economic and inflation forecasts. Those forecasts will determine the pace of the next hike.
Markets sense the ECB will slow the pace back to a 50bps hike, though the account offered no direct support for that view, and remarks from key officials have varied. ECB Chief Economist Philip Lane said the amount of tightening already delivered removed one argument for the need to hike by 75bps again, though Executive Board member Isabel Schnable in a speech said the case to downshift "remains limited" based on the data.
In that respect, the October account revealed that some Governing Council members were of the view that a "shallow or technical recession" would not sufficiently ease inflation pressures in the euro area. The data of note this week showed the euro area is sliding towards a recession as further weakness in activity was reported in November's preliminary PMI readings. The composite index (including manufacturing and services) posted another contractionary reading, in at 47.8 from 47.3 in October. Weakening activity is translating to easing price pressures as input costs for manufacturers fell to their slowest pace in 14 months.
More work in front of the BoE
The Bank of England's Watchers' Conference saw Bank deputy governor Dave Ramsden give a recap of the key developments in the UK economy in 2022 highlighting the energy price shock, labour market tightness, rising inflation expectations, and volatile financial markets. Ramsden said that in a background of elevated uncertainty the BoE has been less confident in its economic forecasts, particularly over the medium-term horizon relevant for monetary policy decisions.
To his own interpretation, Ramsden's assessment was that the BoE's tightening cycle had further to run due to domestic inflationary pressures having not yet abated. Although the government's fiscal support to cap energy prices had reduced some of the upside risk to inflation, more persistent price pressures could be building due to the strength of the labour market and with services sector inflation at a 30-year high.
