Spotlight: Central Banks

FED & BOE FACE A NUMBER OF UNCERTAINTIES The coming week will see five developed economy central banks give monetary policy updates. However, markets will be focused primarily on the US Federal Reserve (Fed) and the Bank of England (BoE). In the run-up to these, markets have so far been relatively quiet. The BoE and Fed meetings take place against a background of mixed economic data. Economic activity in both the US and the UK appears to have slowed during the summer months after an initial surge when restrictions were eased. The deceleration may have more to do with supply constraints rather than a lack of demand but nevertheless at least some policymakers will likely see it as arguing for moving very cautiously when considering any change to the current very easy monetary conditions. Meanwhile, near-term inflation trends remain a concern. In the US, annual CPI inflation dipped modestly in August, providing some support for Fed policymaker’s views that this year’s rise is largely transitory. Nevertheless, inflation is still well above the Fed’s target. In the UK, CPI inflation jumped sharply in August to 3.2%, a near 10-year high. That means BoE Governor Bailey will have to write an open letter to Chancellor Sunak explaining developments. We expect inflation to rise further before year-end, potentially reaching 4% and it now seems likely that it will stay above the 2% target for all of next year - before potentially moving back below target in 2023.

Other factors may also impact monetary policy deliberations. In the US, a Federal budget for next year is still yet to be passed by Congress, while an imminent breach of the debt ceiling is an additional uncertainty. In the UK, a tax increase to fund additional health & social care funding has already been announced and the BoE will be aware that the Budget on 27th October may see some further tightening of fiscal policy. The impact of the furlough scheme ending this month also needs to be factored in. While it is no longer expected that this will lead to a marked rise in unemployment just what will happen to all those workers still on furlough remains uncertain.

MARKETS WAITING FOR FURTHER CLUES ON TAPERING

These uncertainties argue for a largely wait-and-see approach by both the Fed and the BoE. Consequently, next week’s updates will probably be light on immediate policy action, but there may be some clues about future moves. The number one issue for the Fed will be the timing of any ‘tapering’ of its asset purchases. A number of Fed policymakers including Fed Chair Pow ell have suggested that this may be imminent. So it is possible that an announcement may come on Wednesday. However, given that the August US employment report was so disappointing it seems more likely that will come at the meeting in early November with a possible intention of starting tapering from December. Overall the Fed’s message is likely to remain dovish and in particular, it will probably continue to insist that any hike in interest rates will be further in the future. However, the Fed’s forecast updates may see some further change to interest rates expectations with a majority of policymakers possibly now projecting a rate increase by the end of 2022. If so that may cause a few ripples in markets. In the UK, this month’s deliberations of the BoE’s Monetary Policy Committee will include two new members, Huw Pill (the Bank’s new chief economist) and Catherine Mann. This is not one of the meetings where the MPC issues a new policy report or forecast update and so there is no scheduled press conference. The Committee’s vote on the continuation of the current £895bn tranche of asset purchases may again be split 8 to 1, (with external member Saunders once more voting for an early ending. However, as the tranche is set to be used up by year-end that now doesn’t seem to be a major issue and no other immediate policy moves are likely to be seriously considered.

Nevertheless, the MPC’s policy guidance may have implications for market interest rate expectations. Markets are now discounting 40 basis points of rate increases next year w with further rises expected in 2022. In hardening its forward guidance in August, the MPC acknowledged that “some modest tightening in monetary policy” will probably be necessary over the forecast period but will they now feel that the market is factoring in too much of a rise? One thing that could confuse the MPC’s message is that in August, 4 of the 8 members were reported as thinking that the existing minimal conditions for a policy tightening had been met, so if either of the two new participants agree that camp may now be in the majority. That does not mean a policy move is imminent as even those relative ‘hawks’ still acknowledge that this is only a “necessary not sufficient” condition for future tightening. Nevertheless, markets may see it as a hawkish development.

UK PMIS HAVE SLID SHARPLY FROM MAY PEAKS

The September PMIs stand out in a relatively light data calendar for the coming week. The UK manufacturing and services measures have both slowed for three successive months from their May peaks, primarily due to various near-term supply constraints on activity. We expect the manufacturing measure to edge down further in September but services may see a modest rebound. Also of interest will be the GfK consumer confidence reading. In contrast to the US, where confidence slid sharply in August, UK sentiment has so far held up well and analysts expect that to continue in September. The Eurozone PMIs also fell in August but the level of both indices, for now, are above those in the UK, possibly because the easing of restrictions and consequent rebound in activity happened later. We predict further falls in both for September. Finally, the German IFO will also provide indications of the strength of the Eurozone economy in September.

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