Festive Policy Disagreements
Central banks and statistical authorities like to pack the week or two before Christmas with their releases. It makes it easier for markets to digest the news in thin trading and for everyone to digest their festive food. That news flow started this week with a flurry of central bank decisions that included some surprises, but market pricing for the ECB, BoE and Fed was broadly unchanged.
The ECB decision took top billing, matching our expectations by cutting its deposit rate by 25bp to 3%. Dovish hopes for a 50bp punch were disappointed, albeit mostly faded in recent weeks. Removing the reference to sufficiently restrictive policy was reasonable before reaching neutral, with the appropriate determination language being similar. 25bp cuts in January and March would take rates to the upper end of last year’s staff estimates for neutral, which may have risen, justifying not much easing beyond that (see ECB: Removing Restrictiveness).
Decisions elsewhere this week started and ended with no change, albeit in different contexts. Whereas the RBA hasn’t started cutting yet, the BCRP (Peru) first did so over a year ago and is now pausing until news tells it to do something else. Meanwhile, the SNB and Bank of Canada arguably threw caution to the wind with forceful 50bp rate cuts. The SNB’s decision surprised expectations and left rates perilously close to zero (at 0.5%), making FX interventions and negative rates more likely. Canada’s outcome matched modal expectations, but the distribution was split and the dovish outcome arguably a vote of confidence in the Fed cutting next week.
At the other end of the spectrum, Brazil hawkishly surprised with a whopping 100bp rate hike. It also signalled that it may sustain this pace of tightening to get back on top of inflationary pressures. Nor should this be dismissed as a niche South American issue. Brazil has led the global policy cycle by about a year on the tightening and subsequent easing. Maintaining this lead would be consistent with a replay of the 1998 scenario wherein the Fed and others could return to rate hikes around the end of 2025.
A monetary policy reversal remains a distant risk in the markets’ minds. Nonetheless, with the cycle pricing truncated for most except the ECB (we disagree with the ECB’s dovish extent), it sounds far less outlandish than when we started pushing this scenario. It remains the historical norm for when easing has occurred without a recession.
Policy uncertainty related to Trump is a more common refrain among recent central bank decisions. This week, Alastair Newton explored how Xi Jinping’s probable responses to US trade tensions will likely accelerate the ongoing shift from truly global globalisation to multi-polarisation. Investors need to adjust how they view the world accordingly (see China/US: Trading Blows Part 2).
Meanwhile, we fear persistent fiscal deficits have almost become normalised, with politicians hoping that modern monetary theory (MMT) might resolve their borrowing with private savings and assets. Foreign savings are the more likely release valve on discretionary fiscal easing. Pursuing countercyclically loose policy faces inflationary resource constraints even under MMT. Revaluations of heterogeneous securities mean higher deficits and debt are not neutral. Fiscal deficits encourage tighter monetary policy amid stagflationary pressures (see Debunking Fiscal Voodoo).
Partly deficit-financed UK government spending plans should urge caution from the BoE in its upcoming decision, where we and the market expect no change. Another bumper rise in the minimum wage and public sector pay deals compound wage pressures, while downward revisions to productivity make unit pressures even more inflationary. Disappointing GDP and unemployment rate data don’t do enough to offset this, which means the next BoE cut can wait until February, although we expect two doves to vote for an earlier move.
The Fed could arguably also wait. It’s under no recessionary pressure to ease again. But its belief that the high policy rate number is tight enough to be safely lowered means we still expect another 25bp Fed cut this week. The rebound in payrolls wasn’t enough to stop a surprisingly steep rise in the unemployment rate, while US inflation didn’t trend further above target-consistent levels. It will probably pause at the following meeting, with March potentially the last Fed cut.
Neither the BoE on hold nor a 25bp Fed cut would shock where modal expectations have settled. Other upcoming decisions include the risk of a 25bp BOJ hike, Norges Bank and Thailand on hold, while 25bp cuts come from the Riksbank, Chile, Colombia, Mexico, Indonesia and the Philippines.