Inflation is a growing concern
For years central banks have been operating under the assumption that inflation will eventually return to target while having the flexibility to wait until the economy is fully ready for higher rates. That luxury is a thing of the past and many now feel stuck between a rock and a hard place.
Most are hoping that a modest tightening of monetary policy will begin the address the problem and buy them enough time for inflation to show itself to be as transitory as they believe. Some are taking more drastic action with larger rate hikes to quickly bring inflation under control. And then there’s the CBRT.
Next week it’s the ECB’s turn to shed some light on how it will deal with inflation which is running well above target, an unusual problem for the central bank after a decade in which the threat of deflation has been a much greater risk.
The calm before the November 3rd Fed storm should have investors focus on the advance reading of third-quarter GDP, mega-cap tech earnings, and the final version of President Biden’s economic package. The economy was dealt a blow from the delta variant but most of the lost growth appears to be pushed back to next year. On Thursday, analysts expect the economy in the third quarter to slow from 6.7% to 3.0%, which is a reflection of current supply chain issues and not falling demand.
Risk appetite has remained intact as Wall Street continues to overlook supply chain issues, surging commodity prices, and rising transportation costs, but that could change if inflationary pressures intensify. The next round of mega-cap tech earnings from Apple, Amazon, Microsoft, and Facebook could change Wall Street’s expectation on how much pricing pressures are persisting.
Optimism is growing that after some large concessions, Democrats will get Senators Manchin and Sinema on board with President Biden’s economic package. The US economic outlook next year is still looking bright as pent up demand and more stimulus will spur growth.
The ECB meeting next week is the obvious standout event as markets look for clues on how the PEPP program will be replaced when it expires in March and whether it will be tempted to follow other central banks in tightening monetary policy. Headline inflation may be above target but there appears to be a firmer belief than elsewhere that this is temporary and they’ll be back below before long. With that in mind, investors will be keen to know whether other stimulus measures will be introduced in March. They may have to wait until December though when new economic projections will be prepared.
UK businesses and households are facing a squeeze over the next year from higher energy prices, taxes, prices and interest rates as the BoE prepares to raise interest rates to counter high supply-side driven inflation.
That makes the Chancellors Autumn budget on Wednesday all the more important. While the governments focus in the coming years will have to be on paying for the pandemic, they won’t want to act too fast and turn an already sluggish recovery into something worse.
The ruble rallied strongly after the Bank of Russia raised interest rates by 0.75% on Friday, surpassing expectations of a 0.25% or 0.5% hike. Clearly, unlike their Turkish counterparts, the CBR is taking the threat of inflation serious and is prepared to raise them further as it raised its inflation forecast at the end of the year to 7.4-7.9%, almost double its 4% target.
The announcement saw the dollar fall briefly back below 70 against the ruble for the first time since June last year. Higher rates and soaring energy prices have supported the currency in recent months and with more hikes and a possible winter crisis in the pipeline, it could remain in favour for some time.
The unemployment rate on Friday is the only notable release.
The lira fell more than 3% to a record low on Thursday and has continued to slide on Friday after the CBRT cut rates by 2%, at least twice as much as markets expected. The move ends the debate, if there was one, that the central bank is being influenced by President Erdogan, whose long-held views that high-interest rates spur inflation are well known.
The central banks’ credibility under Şahap Kavcıoğlu is ruined and its only hope of avoiding further troubles down the road is inflation falling…
Read More: Week Ahead – Between a Rock and a Hard Place