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Friday 14th January 2022
Hi Friend,
Friday Forward Guidance ...
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| | The Saturday Economist Friday Forward Guidance ...
This is our Friday Forward Guidance for Friday 7th January. 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.
Our outlook is slightly more hawkish this week. Federal Reserve Chair Jerome Powell confirmed the central bank will prevent higher inflation from becoming entrenched. CPI inflation hit 7% in December. Producer prices were up 9.7%, the highest level in forty years.
Goldman Sachs thinks the Fed will raise rates four times this year. Bloomberg economist David Wilcox thinks the latest forecasts for unemployment and core inflation are consistent with six hikes this year.
Ten year bond yields were unmoved through the week. The Dollar slipped against Sterling and the Euro. The strength of Sterling was explained by the prospect of Boris Johnson leaving Number Ten. Which just goes to prove, when it comes to understanding market moves, "Any explanation is better than none" (Nietzsche).
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| | Fed Funds Rate ...
The Fed Chair Jerome Powell confirmed this week, "We will use our tools to support the economy and a strong labor market and to prevent higher inflation from becoming entrenched." This was included in a brief opening statement prepared for delivery at his confirmation hearing before the Senate Banking Committee.
Goldman Sachs expects the Fed to raise rates four times this year. Bloomberg economist David Wilcox thinks the latest economic forecasts are consistent with six hikes this year and another three in 2023.
We now expect four base rate hikes from end of Q1 onward, 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 1.00%. The projections remain broadly in line with the FOMC December
Blue Dot Plot. This is our "We are leaving Planet ZIRP" scenario. Grab a ticket for the flight, don't forget the cancellation insurance.
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| Fed Funds Rate 2021 2022 2023 2024 2025 Long Run Rate
Q4 0.10% 1.00% 1.50% 2.00% 2.50% 3.50%
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| | Bank Base Rate...
CPI inflation increased to 5.1% in November. The Bank expects inflation
to peak at over 6% in April. The inflation and job market updates are out next week.
The latest GDP numbers for November confirm growth was up in the month by over 8%. For the year as a whole we now expect growth closer to 8% than the 7% penciled in by most analysts. In 2023 we model growth of 5.5%.
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 0.95% in the final quarter. We expect more to follow in 2023, pushing to 1.50 at close.
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| Bank Base Rate 2021 2022 2023 2024 2025 Long Run Rate
Q4 0.25% 0.95% 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. Inflation in the euro area is expected to fall back below the 2% goal in 2023 and stay there in 2024, despite strong economic growth. Big call!
President Christine Lagarde has said rate increases are still “very unlikely” this year but she is prepared to change her mind should consumer prices rise more quickly than expected.
December inflation hit 5% in Euro-land. In Germany, land of the inflation prone Wiemar Republic, HICP inflation hit 5.7% in the month. Bavarian Premier Markus Soeder called on the ECB to tighten monetary policy to control inflation.
If our expectations for US
and UK rates hold, we would Euro rates could close at 0.25% by the end
of 2022 at least, to avoid significant pressure on the Euro.
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| ECB Base Rate 2021 2022 2023 2024 2025 Long Run Rate
Q4 0.00% 0.25% 0.50% 0.75% 2.50% 3.50%
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| | | This is the table of scenario comparisons. We would 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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© 2022 John Ashcroft, Economics, Strategy and Financial Markets, experience worth sharing.
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