Will the Fed speed up its ‘tapering’ of bond purchases?

Will the Federal Reserve speed up its ‘tapering’ of bond purchases?

When US policymakers convene on Tuesday, they are set to discuss how quickly they may need to scale back the central bank’s asset-purchase programme in order to give them the flexibility to raise interest rates next year.

Just last month, the Federal Reserve announced it would reduce its $120bn bond-buying programme at a pace of $15bn per month. That suggested the stimulus would cease by the end of June.

A string of recent economic reports showing a tightening labour market and mounting evidence that inflationary pressures are broadening and becoming more persistent has prompted a pivot from Jay Powell and other senior officials.

During congressional hearings earlier this month, the Fed chair signalled his support for wrapping up the so-called taper “perhaps a few months sooner” than initially planned. Market expectations immediately adjusted, with investors pricing in the first interest rate increase in June, with at least one more slated for later in the year.

More than half of the 48 economists who participated in a recent survey conducted by the Financial Times and the Initiative on Global Markets at the University of Chicago Booth School of Business said it was “somewhat” or “very” likely the Fed would stop adding to the size of its balance sheet by the end of March.

That may allow for a rate increase as early as the first quarter, which 10 per cent of the respondents thought plausible. The majority, however, say the Fed will move in the following quarter.

The two-day meeting, which will conclude with a press conference on Wednesday, will be accompanied by a new set of economic projections as well as an updated “dot plot” of individual interest rate projections.

September’s edition, which was the last time the dot plot was published, showed officials evenly split on the prospects of a 2022 rate increase, with at least three slated for 2023 and another three for 2024. Economists this time expect multiple adjustments to be pencilled in for next year and subsequent periods. Colby Smith

Will Omicron keep the Bank of England on hold?

Investors have dialled back their bets on the Bank of England raising rates this month as the spread of the Omicron coronavirus variant muddies the outlook for the domestic economy.

Markets are pricing a roughly one-in-three chance the bank on Thursday will announce an increase in borrowing costs to 0.25 per cent from the current record low of 0.1 per cent. Those odds stood at around 75 per cent in late November before the new variant emerged.

Michael Saunders — one of two BoE rate-setters to back a rise in November — said earlier this month there could be “advantages” to waiting to see how Omicron affects the economy before tightening monetary policy.

The impact is likely to be relatively small, shaving 0.1 percentage points off growth in the current quarter, according to economists at Goldman Sachs, who added that the labour market and wage growth remained strong. The BoE will instead be focused on “risk management” and so is likely to keep rates on hold, they said. Still, data released on Friday showed the UK economy barely grew in October as supply chain disruption hit manufacturing and construction, while the expansion of the services sector slowed.

“This remains a close call,” Goldman said in a note. “We expect the [BoE] to signal that this is only a short delay to gather more information on Omicron, and indicate that a hike remains appropriate in coming months.”

Markets are currently fully pricing in lift-off at the next BoE meeting in February. If the Bank stays put on Thursday it will come as less of a surprise than its November meeting, when policymakers confounded investor expectations of a rate rise, sending sterling tumbling. Tommy Stubbington

Will the ECB raise its forecast for price growth?

Christine Lagarde will this week kick off the process of withdrawing the massive monetary stimulus launched by the European Central Bank to shield the economy from the fallout of the pandemic last year.

Having bought €2.2tn of mostly government bonds and given a similar amount of ultra-cheap loans to banks since the virus struck, the ECB president has a long way to go to normalise monetary policy.

Lagarde will almost certainly start by announcing on Thursday that the €1.85tn Pandemic Emergency Purchase Programme — the bank’s flagship response to the crisis — will stop net purchases in March, as she already signalled in October.

The key question for investors is how many bonds the ECB will commit to buying after March. Most analysts expect it to reduce the “cliff edge” in its bond-buying after March by ramping up an older quantitative easing scheme, which is still hoovering up €20bn of assets a month.

It could do this by increasing monthly purchases under the older Asset Purchase Programme to about €40bn or by adding an extra “envelope” of several hundred billion euros to spend over the rest of the year.

“I think they are going to try and engineer a dovish transition,” said Peter Goves, European interest rate strategist at MFS Investment Management.

After eurozone inflation shot up faster than expected to hit 4.9 per cent in November, the highest level since the single currency was launched more than 20 years ago, the ECB is also expected to raise its forecast for price growth to exceed its 2 per cent target both this year and next year. It will be the first time this has happened in a decade.

But it is also likely to forecast that inflation will drop back below its target in 2023 and 2024, albeit narrowly, justifying its decision to maintain a sizeable stimulus for most of next year. Martin Arnold

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