The uptrend in global monetary accommodation continues uninterrupted, and is also conditioning, via currency market movements, the intentions of the very few central banks preparing for a rate shift (Fed and BoE). In the past few days, new accommodative measures have been put in place, and central banks have expressed concern over the strengthening of their currencies and/or weak growth and inflation….
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The Riksbank has cut rates for the second time in a month, placing its policy rate at -0.25% from -0.10%, and stepping up its asset purchase programme by 30 billion kronas. The central bank said its decision was mostly prompted by the strengthening of the exchange rate, up in the past month by around 5% against the euro. The Riksbank’s concern is that the strength of the krona may reverse the modest inflation uptrend. The SNB has made it clear it intends to prevent an appreciation of the franc, which in its view remains “significantly overestimated”; the central bank intends to “remain active in the foreign exchange market, as necessary”. The Norges Bank left rates unchanged at its March meeting, after cutting them in December, but has shifted downwards the expected rate path, signalling a likely rate cut between May and June, stating that thre are “prospects for a reduction in the key policy rate”.
The minutes of the Bank of England’s March meeting also reveal a more cautious approach to the process of reversing policy rates. The BoE again took on the topic of the depressive effects on inflation of the strong exchange rate, cooling expectations in terms of the probability of an initial rate hike coming this year. Also, the BoE’s head of economic research actually mentioned the possibility of rates being cut. In our view, the BoE’s current stance should be read as a wait-and-see position, rather than foreboding a revision of the expected rate hike path. With the Fed’s reversal due in 2H 2015, we believe the BoE is likely to start increasing rates in the closing months of this year.
In this context of global easing, with the USD effective exchange rate strengthening by 3.5% between end of February and mid-March, the Federal Reserve brought radical changes to its growth and inflation projections at the march meeting . With the new macroeconomic outlook and full employment postponed to end-2015, the expected path of interest rates has obviously shifted downwards. The overwhelming majority of participants (15 out of 17) believes it will be appropriate to raise rates in 2015, but the pace of the upward cycle and the point of arrival at the end of 2017 are significantly below the December forecasts: the median projections are 0.5-0.75% at the end of 2015, 1.75-2% at the end of 2016, 3-3,25% at the end of 2017. On the longer run, the point of arrival remains 3.75%. Yellen also specified that the rate increases will depend on the main variables (labour market and inflation) and will not necessarily respond to wages: an acceleration of the wage trend is possible in the coming quarters, but the Fed seems to be shifting its focus again.
What are the implications for the interest rate path? Based on the new projections, two hikes should come this year: we think it reasonable to assume one will be implemented per quarter. Data and macroeconomic conditions will provide indications in the months ahead. If the FOMC’s intention is to weaken the dollar, without going too far, we think it likely that the first hike may come between June and September, and the second in December. We maintain a preference for the first hike occurring between June and July, given the expected labor market improvement and the likelihood of at least stable core inflation. We stick to our forecast for a hike a quarter in 2016.
The FOMC’s new guidance is conveyed through macro projections and the dot chart: financial conditions become much more accommodative, with lower rates and a less expensive exchange rate. This strengthens confidence in growth forecasts well above potential, at close to 3%.
Appendix
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