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Friday 3rd December 2021
Hi Friend,
Friday Forward Guidance ...
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The Saturday Economist Friday Forward Guidance ...
This is our Friday Forward Guidance for Friday 3rd December. Every week we update our scenario forecasts for base rates in the U.S. UK and Europe over a three year period. We also include our expectations for inflation as an input to the central bank reaction function in the Saturday Economist updates.
Markets were moved this week. Jerome Powell suggested inflation may not be as transitory as first thought. Tapering may be ended sooner than expected. U.S. base rates may rise in the second half of next year. We now expect two rate hikes in the second half of next year to 0.5%, tapering concluded by the end of Q2.
When it comes to understanding market moves, "Any explanation is better than none" (Nietzsche).
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Fed Funds Rate ...
Markets were moved this week. Jerome Powell suggested inflation may not be quite as transitory as first thought.
In testimony before the Senate Banking Committee, Powell said "It now appears that factors pushing inflation upward will linger well into next year. In addition, with the rapid improvement in the labor market, slack is diminishing and wages are rising at a brisk pace."
The Fed is now expected to accelerate tapering of the bond buying process. We attach a higher probability to conclusion of the asset purchase program by the end of Q2 next year. This would leave the way open to two base rate hikes in the second half of the year, rising to 2.50% by the end of 2025. This is our "We are leaving Planet ZIRP" scenario.
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Fed Funds Rate 2021 2022 2023 2024 2025 Long Run Rate
Q4 0.10% 0.50% 1.00% 1.75% 2.50% 3.5%
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Bank Base Rate...
Andrew Bailey, Governor of the Bank of England, explained recently "Forward Guidance is a murky business. The boundary between commentary on the state of the economy and what the central bank is likely to do with interest rates is hard to define".
The Governor hinted he may be more likely to vote for a rate rise in future meetings of the MPC. Huw Pill, Chief Economist at the Bank suggested rates could rise as early as this month.
At the last MPC meeting, the vote was 7 - 2 in favor of keeping rates on hold, Silvana Tenreyro a determined dove. There has been no rate rise in December for over fifty years. We expect the first rate rise, late into Q1 next year, with two rate rises possible before the end of the year, rising to 2.50% by the end of 2025.
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Bank Base Rate 2021 2022 2023 2024 2025 Long Run Rate
Q4 0.10% 0.75% 1.50% 1.75% 2.50% 3.50%
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Euro Base Rate...
Christine Lagarde, President of the the EU Central Bank had suggested European rates could stay on hold through 2022. Then last week, the latest data on inflation was released by Eurostat.
Euro area annual inflation is expected to be 4.9% in November up from 4.1% in October. This according to the latest flash estimate from the statistical office of the European Union.
Energy costs the main contributor up by 27% in the month. Good news in December. Oil prices trade at $71.41 Brent Crude basis this morning. Gas prices are down 30% from the October peak. We present below the implied EU bank scenario. If our expectations for US and UK rates hold, we would expect Euro rates to close at 0.50% by the end of the year.
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ECB Base Rate 2021 2022 2023 2024 2025 Long Run Rate
Q4 0.00% 0.00% 0.50% 0.75% 2.50% 3.50%
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Our modified Taylor rule suggests the UK central bank is behind the curve on rate hikes. Here we model base rates as a function of inflation variance from target and the output gap relative to trend growth. The implication is base rates should close the year at 1.25% in 2021, rising to 1.50% by the end of 2022. This is a benchmark not a forecast!
Taylor Rule UK 2021 2022 2023 2024 2025 Long Run Rate
Q4 1.25% 1.50% 1.50% 1.75% 2.50% 3.50%
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This is the table of scenario comparisons. We would normally expect UK rates to lag not lead the US pattern. EU rates would follow the US/UK lead. Inflation may subside sooner than expected, central banks may worry about the shock to growth. The escape from Planet ZIRP may be aborted. This is a scenario not the plan.
Comparisons 2021 2022 2023 2024 2025 Long Run Rate?
US 0.10% 0.50% 1.00% 1.75% 2.50% 3.50%
UK 0.10% 0.75% 1.50% 1.75% 2.50% 3.50% Euroland 0.00% 0.00% 0.50% 0.75% 1.75% 3.50% Taylor Rules UK 1.25% 1.50% 1.50% 1.75% 2.50% 3.50% |
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That's all for this week's Friday Forward Guidance. Don't miss the Saturday Economist Out Tomorrow ... and our market updates on Monday ...
John
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© 2021 John Ashcroft, Economics, Strategy and Financial Markets, experience worth sharing.
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