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Friday 17th 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 17th 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.
US inflation hit 6.2% in November. UK inflation increased to 5.1%. Despite concerns about the Omicron variant, the Fed and the Old Lady were obliged to make the move. We are leaving Planet ZIRP. Travel plans may be denied, cancellation insurance advisable.
Our rate
scenarios reflect the decisions of the FOMC, the MPC and the ECB this
week. The Fed voted to end tapering in March. The MPC voted
to increase base rates in December. The
ECB confirmed plans to terminate net purchases of PEPP, the Pandemic
Emergency Purchase Plan in Q1.
US markets closed down. Sterling moved up. Bond yields remain unconvinced of the longer term plan. When it comes to understanding market moves, "Any explanation is better than none" (Nietzsche).
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| | Fed Funds Rate ...
Former Treasury Secretary, Larry Summers suggested the Fed should signal four rate hikes in 2022 to restore the bank's credibility in the fight against inflation.
High inflation
and low unemployment prompted a Powell pivot this month. The Fed voted
to accelerate asset tapering. Plans were announced to end the tapering process by
the end of March next year. This would open up the option to raise rates
in Q2, rather than wait until the second half of the year.
We
attach a 90% probability to conclusion of the asset purchase program
by the end of Q1 next year. This would leave the way open to two or
three base rate hikes from Q2 onwards, rising to 2.50% by the end of
2025. The earlier move would offer symmetry with the UK direction of travel.
US rates would end the year at 0.85%. The projections are in line with the FOMC December
Blue Dot Plot. This is our "We are leaving Planet ZIRP" scenario. |
| Fed Funds Rate 2021 2022 2023 2024 2025 Long Run Rate
Q4 0.10% 0.85% 1.50% 2.00% 2.50% 3.50%
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| | Bank Base Rate...
Last week we said, there has
been no rate rise in December for over fifty years! We expected the
first rate rise, in Q1 next year, with two further rate rises
possible before the end of the year.
CPI inflation increased to 5.1% in November. The Bank expects inflation
to peak at over 6% in April. The MPC policy makers, with the exception
of Silvana Tenreyro, were left with little choice but to vote for a
rate increase.
In the December meeting, the MPC voted 8 - 1 to
increase base rates by 15 basis points. We expect two further rate rises
in 2022. The first, in the second quarter next year.
The market-implied path for Bank Rate hits 1.1% by the end of 2022. We assume the pattern of rate hikes, will hold in line with US Fed
policy, to close at 0.75% in the final quarter. The full 100 basis points may be too much of a stretch.
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| Bank Base Rate 2021 2022 2023 2024 2025 Long Run Rate
Q4 0.25% 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. The ECB announced plans to terminate net purchases
under PEPP, the Pandemic Emergency Purchase Plan, at the end of March
next year.
The
governing council had decided to increase the initial €750 billion for
the PEPP by €600 billion in June 2020 and €500 billion in December for a
total of €1,850 billion. Roll over funds would be re invested until the end of 2023.
We
present the implied EU bank scenario. If our expectations for US
and UK rates hold, we would Euro rates could close at 0.50% by the end
of 2022 at least, to avoid significant pressure on the Euro. |
| 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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| | | 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. Concerns over the Omicron variant may increase. The escape from Planet ZIRP could be aborted. This is a scenario not the plan.
Our modified Taylor rule suggests the UK central bank is behind the curve on rate hikes. In our modified Taylor rule 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 and by 1.50% by the end of 2022. This is a benchmark not a forecast!
We model the long run rate at 3.50%. The Fed Blue dot projections assume 2.50% as the perceived long run rate. In the UK, prior to the Great Financial Crash [2000 - 2008] the average inflation rate was 2.0%, the average UK bank rate was 4.50%. Ten year bond yields averaged 4.50%.
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| | That's all for this week's Friday Forward Guidance. Don't miss the Saturday Economist Out Tomorrow ...
John
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