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Policy Remains Highly Accommodative Despite High Nominal Growth - Action Forex

Markets

Yesterday, multiple central banks including the Bank of England and the ECB met for their last meeting of the year. For most of them, accelerating inflation put policy normalization on top of the agenda. The BoE took a qualitative step. As the asset purchase program has been completed, Bailey an Co immediately moved to a next phase, raising the policy rate by 15 bps to 0.25%. While the impact of ending the furlough scheme was still a concern at the November meeting, persistent strong labour data and inflation accelerating above 5% this time forced the BoE to prioritize inflation. The Bank didn’t give clear guidance on the timing of further hikes. However, with inflation expected to stay at current or higher levels until April, follow-up action might already come in spring or earlier. UK yields initially jumped up to 9 bp higher, but gains evaporated in a broader risk-off move. Initial gains of sterling (against the euro) were also reversed after the ECB policy announcement. EUR/GBP closed at 0.8505, only little changed from Thursday (0.8515). The ECB laid out the roadmap for policy as net PEPP purchases will stop end March 2022. However, Lagarde and Co delivered a recalibration, rather than a qualitative step to profound policy normalization. PEPP reinvestments even will be extended at least till the end of 2024. Net PEPP purchases in the first quarter of next year will slow from current pace. To secure a smooth transition post PEPP, purchases under APP will be raised to € 40bln p/m in Q2 to be reduced back to € 20bln in Q4. Omicron/the development of the pandemic remain a key source of uncertainty and the ECB still sees the need for continued policy accommodation. Growth is expected to stay strong (5.1% 2021; 4.2% 2020; 2.9% 2023). Inflation was upwardly revised to 2.6% this year, 3.2% next year but is expected to return below target (1.8%) in 2023 and 2024. The ECB will evaluate policy metrics on a quarterly basis, but Lagarde reiterated that rate hikes in 2022 are unlikely. Yesterday’s ECB action is subject to divergent interpretation. Policy remains highly accommodative despite high nominal growth. At the same time, some market participates will consider it as potentially opening the door toward (accelerated?) policy normalization next year. German yields initially jumped 5+ bps, but also didn’t withstand a deepening US risk-off correction (Dow -0.8%; Nasdaq -2.47%). German yields closed between -0.1 bp (2-y) and +4.1 bps (30-y). US yields declined between 8.1 bps (5-y) and 0.75 bps (30-y). Both for the German and the US 10-y yield the technical picture remains fragile. The former struggles to regain the -0.35%. The US 10-y yield is at risk to fall below the 1.41% support. A break would bring this month’s low (1.33%) on the radar.

On FX, the ‘ECB roadmap’ triggered a EUR/USD short-squeeze with the pair touching the 1.136 area. Momentum slowed soon, but the sharp decline in US yields weighed on the dollar and allowed EUR/USD to close well north of 1.13 (1.1330). EUR/USD created some breathing space off the 1.1186/1.1222 support area, but only a sustained break above 1.1385 would signal that the single currency could enter calmer waters. The trade-weighted dollar (DXY 95.94) trades off the recent highs. For this index, 95.51 is first important reference on the charts.

News headlines

The Bank of Japan kept the policy rate steady at -0.10% and the 10y yield target at 0%. It did scale back some of its stimulus measures. The quota for extra purchases of corporate bonds introduced after the pandemic struck will end in March next year. Outstanding corporate holdings from then on will gradually be rolled off to about half of the 11tn today. Its emergency funding scheme providing loan support ends as planned on March 2022 for large enterprises but has been extended by six months for SMEs. Monetary policy support is very generous still though as inflation remains subdued while omicron poses new threats. The Japanese yen trades little changed near USD/JPY 113.5.

Mexico’s central bank raised the policy rate by 50 bps to 5.5% yesterday. The bigger-than-expected hike was warranted by increasing inflation forecasts and upside risks as well as other central banks (including the Fed) moving towards a faster tightening pace. The central bank projects prices to rise with a peak rate of 7.1% in Q4 this year and will only ease close to the 3% target in 2023. Officials left the door open for more hikes, most likely in clips of 50 bps. The Mexican peso yesterday strengthened, sending USD/MXN below 21.

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