The Last Dovish Central Bank (Bank Of Japan) Finally Caved To Market Pressure
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Latest thoughts on global central bank policy (continued)
Growing more cautious
In a period of extreme market volatility due to the political turmoil originated by the mini-budget announcement in September, later scaled down by the new government, the BoE had to hike by 125 bps over the past two meetings, bringing the policy rate to 3.5% in December. Although the last 50-bp move was anticipated, the Monetary Policy Committee (MPC) vote was a dovish surprise with two members voting for no change. The policy calibration will be set on a meeting-by-meeting approach with a particular focus on wage developments and the persistence of domestic price pressures they are likely causing. The burden of proof is thus on data and a faster-than-expected weakening in the labor market, which could lead to a slowdown in tightening going forward. Internal divisions within the MPC will deepen as the United Kingdom is expected to enter a recession. We now expect a terminal rate of 4.5% with one more 50-bp increase in February, although the policy path will be more data dependent than before, and two more 25-bp hikes in March and May. After the delayed start due to abrupt moves in long dated gilts (UK government bonds) in the wake of the mini-budget, active quantitative tightening began in November without further complications.
Close to peak rate
After having slowed down its pace of hiking to 25 bps in November, Norges further hiked its policy rate to 2.75% in December. Despite data coming in on the hawkish side, the deceleration of tightening stemmed from a more careful calibration as some signs of transmission to the real economy became visible. Although the labor market remains tight and wage growth resilient, vacancies and labor shortages are decreasing, and house prices are falling faster than anticipated. The expected policy path was revised downward in the long end and now anticipates some cuts from 2024 onwards. As Norges Bank was the first central bank to embark on its hiking cycle (in September 2021), it will likely be the first to end it, but the hawkish indications from the Fed and ECB on the length of the cycle might add some pressure down the line. We still expect a peak rate of 3.25% by May, acknowledging downside risks to the call.
Attentive calibration going forward
With fewer meetings scheduled compared to regional and global peers, the Riksbank hiked by 175 bps over the last two meetings to a 2.5% repurchase (repo) rate. Going forward, a quickly deteriorating housing market and hawkish pressures from other central banks will require a delicate balancing act. Sweden’s interest-rate sensitivity is enhanced by a leveraged household sector, which will be hit by increasing interest expenses, limiting the upside for rates as house prices are already plummeting. On the other hand, the clear hawkish ECB message will challenge the historical interest-rate differential premium between the two. We expect another 50-bp hike in February, while a further 25 bps in March will depend on the most recent inflation and housing developments. The rate path uncertainty remains particularly high also due to two new board members, including the Governor Erik Thedéen. As the Riksbank previously announced, it will cease quantitative easing (QE) reinvestments this year and it expects the balance sheet to shrink relatively fast compared to other central banks.
Slows pace of hiking, signals more tightening in the pipeline
The SNB slowed the pace of tightening at its December meeting with a 50-bp increase. With this third hike, the Bank has lifted its policy rate by a cumulative 175 bps since the tightening process began in June 2022—the fastest increase since 2000. The bank has also signaled that additional hikes cannot be ruled out just yet. While the SNB’s decision to hike in March will likely be guided by its evaluation of the Swiss franc’s value in the coming months, we also note that the SNB’s inflation forecasts remain broadly unchanged since its September meeting. This suggests that not only does the central bank not believe that the policy rate is high enough to slow down inflation, but it also does not yet consider its policy to be restrictive given that inflation is likely to re-accelerate in late-2024. Therefore, while our base case is for a 25-bp hike, if the franc continues to hold well until the March meeting, the SNB could opt to stay on hold. The SNB has also vowed to remain active on the foreign exchange market, with Chairman Thomas Jordan even confirming the SNB had sold foreign currency in recent months.
Surprise, surprise!
In a surprise move, the BoJ tweaked its Yield Curve Control (YCC) framework at its December policy meeting, widening the band for 10-year Japanese government bonds (JGB) yields to move from 25 bps to 50 bps around its 0.0% target. While making it amply clear that this change was neither tightening nor an exit from its accommodative policy, it does signal that even the last dovish central bank finally caved to market pressure. If the move’s sole intent was to smooth market conditions, we cannot rule out further tweaks. However, for a sustained pivot to a tightening stance, the central bank will need to continue to keep an eye on the inflation-growth mix. While growth is holding up well as the economy opens and supply chain pressures ease, inflation is becoming more entrenched. The core Consumer Price Index (CPI) in November touched 3.7%, the highest in four decades and well above the 2% target. We will continue to monitor the evolution of price pressures in Japan to predict a clear tightening move, including wage pressures and services inflation. For now, we remain more bullish on inflationary pressures in 2023 and a likely pivot in 2023.
Source: cbw-0123-u.pdf (widen.net)
