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Friday 21st 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 21st 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 pretty much unchanged this week. Hawks in the U.S. are reconciled to four rate hikes this year. Some think the Fed will move in 50 basis points steps to bring the party to a close. Bank of England Governor Andrew Bailey reacted to the jump in CPI inflation to 5.4% in December suggesting prices will remain above target into 2023. No surprise there.
In Europe pressure is rising on the ECB to tighten policy in a move against inflation. Christine Lagarde continues to think price pressures will ease later this year and will not be rushed into action.
Ten year bond yields moved higher in the week. U.S. equities took a hit. Sterling moved lower against the Dollar. Bitcoin trades below $39,000 dollars as we write. Don't miss The Saturday Economist out tomorrow We talk about inflation and the jobs market. Don't miss Our Monday Morning Markets, out on Monday, as we review the equity sell off and bond yield rise this week.
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| | Fed Funds Rate ...
The Fed Chair Jerome Powell confirmed last week, "We will use our tools to support the economy and a strong labor market and to prevent higher inflation from becoming entrenched."
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. Some now think the Fed will kick off with a 50 basis point hike to set the mood!
We 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 5.4% in December. The Bank expects inflation
to peak at over 6% in April. Governor Andrew Bailey warns inflation pressures may last longer than thought. Inflation may remain above target into 2023.
Energy prices are expected to ease into the second half of the year. Oil Brent Crude trades at $87 dollars this morning. Gas prices are down 9% in the week. The geopolitical risks in Ukraine and the Houthi attacks on Abu Dhabi weigh on price levels.
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. Real incomes are under pressure in the first half of the year but should balance out into the final quarter. The MPC should commit to the great escape from Planet ZIRP.
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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. Big call!
Lagarde rejected calls to raise rates more quickly than planned. the bank had "every reason not to act as quickly or as ruthlessly as the Federal Reserve". Rising rates too quickly would "put the brakes on growth" she said.
December inflation hit 5% in Euro-land. In Germany, 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. It could well be higher closing at 0.50%.
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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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| | | Scenario Comparisons ...
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. Russia may step over the border into Ukraine. 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%. Some way to go yet!
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| | That's all for this week's Friday Forward Guidance. Don't miss the Saturday Economist Out Tomorrow ... and our Monday Morning Markets out on Monday ...
John
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