On November 15, 2016, four economists from BSI Economics (1 rating agency, 1 bank, 1 central banker, 1 academic) met to discuss upcoming announcements from central banks and economic conditions in the United States, the United Kingdom, and the eurozone.
The Fed Fund rate hike could have a minor impact on the markets on December 14, 2016
A 25 basis point rise in Fed Funds rates is expected. S. Fisher, Vice Chairman of the Fed, recently mentioned the excellent year on the labor market and suggested that a rise was likely in the very near future. This is already priced into financial markets, as evidenced by tighter financial conditions based on reforms in the US money market and expectations of a key rate hike in December. The prospects for rate hikes in 2017 have been debated. Two increases are expected next year due to: (1) the Fed’s desire to continue normalizing rates, (2) the election of Donald Trump, who promised during his campaign to increase public spending and reduce the tax burden, which would lead to more activity and inflation in the short term. On the sidelines of these discussions, two other topics were discussed: (1) the risk of financial instability if the Dodd-Frank Act of 2010, which Trump has promised to repeal, is repealed; (2) the relationship between the US dollar, which is currently appreciating, and the anticipated deterioration in the public deficit in the event of a sharp acceleration in federal spending, particularly to finance infrastructure programs.
Further action expected from the European Central Bank on December 8, 2016
With regard to the European Central Bank, experts believe that a six-month extension of the quantitative easing program is likely, with monthly purchases still expected to total €80 billion. This is to meet investor expectations by sending a positive signal about European monetary policy. Comments by B. Coeuré regarding weak core inflation in the eurozone and announcements by P. Praet of an accommodative monetary policy aimed at achieving the 2% year-on-year inflation target are in line with these expectations. A cut in the deposit rate is one possibility that has been mentioned, which would be particularly useful in promoting a depreciation of the euro. However, three factors make this move unlikely: (1) expectations of a rise in Fed Fund rates, which would increase the interest rate differential between the eurozone and the United States and thus make a cut in the deposit rate less necessary; (2) the concerns recently highlighted by many ECB members regarding the dangers of low rates for the financial system; (3) the appreciation of the US dollar against all currencies, particularly the euro, which makes a cut in the deposit rate less necessary to depreciate the euro.
The parameters of the quantitative and qualitative program were also discussed. The possibility of a targeted yield curve policy in the sovereign bond segment was raised, but attention focused mainly on revising the theoretical allocation of monthly purchases by member country. The possibility of further purchases of peripheral debt, beyond their contribution to activity in the eurozone, remains under discussion.
New ECB economic forecasts through 2019 and a Brent crude price of $60 per barrel
All of the new measures taken by the ECB will be conditional on the new economic forecasts, which include two new elements: (1) forecasts for 2019, which will make it possible to verify whether the output gap could narrow sufficiently to reach the annual price increase target of 2%, (2) higher inflation based on Brent futures prices revised upwards in the event of an OPEC agreement between November 25 and 30, 2016. On this last point, some experts are optimistic that the price of Brent crude will rise to around $60 by the end of 2016. The production surplus could be offset by an agreement to cap production and reduce it by 750,000 to 1 million barrels per day.
Bank of England more tolerant of inflation
The figures on UK economic activity following Brexit remain positive, but a deterioration is expected. The Bank of England lost credibility by revising its forward guidance announced in August—an additional rate cut by the end of the year. The trade-off between stabilizing economic activity and 2% inflation should favor the former, leading the BoE to tolerate more inflation, while remaining cautious in its economic forecasts due to limited visibility on the real impacts of the June 23, 2016 referendum and the risk of underestimating the impact of the pound’s depreciation on imported inflation.
