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Commentary from abrdn economists on Fed, ECB and BofE outlook

Luke Bartholomew (pictured), Senior Economist, abrdn on the Bank of England: 

“Given the heightened uncertainty around the economic outlook following the emergence of the Omicron variant, we now expect the Bank of England to keep policy on hold at is meeting on December 16th. This is a finely balanced call given the conflict between risk management considerations versus the strong labour market data. 

“Overall, we think the Bank will prefer to wait for more information on the severity of the variant and sustainability of restrictions before tightening policy at its February meeting. We still expect Bank Rate to reach 75bps by the end of 2022, with rates reaching 50bps (and so passive balance sheet reduction starting) in May 2022. 

“Despite the short term hit to activity, if anything the risks are now skewed towards more hikes eventually being delivered as the supply impact of this shock may end up outweighing the demand impact, which would put further upward pressure on inflation.” 

Pietro Baffico, European Economist, abrdn on the ECB:

“The upcoming ECB meeting on December 16th will be an important one as the ECB will decide on the future of its QE programmes. We continue to think that the ECB will remain a dovish standout among the major central banks, announcing enhanced flexibility for the standard asset purchase facility  even as the pandemic support measures expire on schedule in March 2022. 

“The ECB has reiterated on various occasions that it views the current inflationary pressures as transitory. However, there has been a growing divergence of views within the Governing Council, with a few hawks becoming more vocal about their concerns recently, and are expected to try to limit the expansion of the APP. At the same time, the latest Covid-19 developments renewed uncertainty, calling for a more gradual and cautious policy response. 

“We expect the total monthly pace of net asset purchases to gradually decline, with PEPP ending on schedule in March next year. Yet, we think the ECB will deliver an additional volume of purchases above the current €20bn of the monthly net APP, with enhanced flexibility around these purchases, for an additional period of about 9 to 12 months.  We estimate up to €240bn additional capacity could be provided, although this full envelope may not necessarily be used, depending on how the economy evolves. 

“There will be other few important aspects of next week’s meeting: the quarterly macroeconomic forecasts are due, which will stretch to 2024, and should provide more insight on ECB’s medium-term inflation outlook. The forward guidance is expected to remain unchanged, and we expect the current sequencing to be retained: since net asset purchases should end before rates are raised, interest rates increases in 2022 would automatically be excluded. A decision on TLTROs (targeted longer-term refinancing operations) funding might also be due. However, the ECB has signaled concerns on the risks of cliff edge effects in liquidity provision and impact on bank credit. Thus, the ECB could delay the decision, with TLTRO conditions revisited later in 2022. 

“Overall, we expect the ECB to remain a dovish standout among the major central banks, keeping a cautious stance and retaining flexibility around its policies.” 

James McCann, Deputy Chief Economist, abrdn on the Fed:

“This meeting is really about seeing how far Powell’s new hawkish tilt will go. We expect the Fed to announce a faster pace of tapering, which will act as the main signal that the central bank’s tolerance for surging inflation has been exhausted. Finishing tapering sooner also clears the way for the Fed to raise interest rates sooner. As a result, we expect the Fed to signal that they will do just that: raise rates three times in 2022 alone. None of this should cause markets to fall out of bed.

“What’s going to be more interesting is what signal we get about where interest rates might peak. At the moment markets expect the Fed to stop hiking when rates reach around 1.5%, but the Fed is likely to signal a higher terminal rate for a couple of reasons. First, the median FOMC member thinks that neutral interest rates sit at 2.5%, which implies that a larger tightening cycle is needed to fully withdraw policy accommodation. Second, there is a chance that the Fed will feel the need to push policy above this neutral interest rate, if it fears that high inflation is becoming entrenched in the economy and needs to be more forcefully pushed back on. 

“Chair Powell might try soften this message by highlighting the uncertainty around where rates will peak, and most of all around the slippery concept of neutral interest rates. But there is a risk that markets sniff a policy mistake. Financial stress around Fed tightening episodes has in the past ground these policies to a halt, albeit under more benign inflation environments. The risk this time is that the Fed does not feel it can back down, leading to more acute market disruptions.”

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