Last week was a busy one for central bank activity with the Fed, Bank of England and Bank of Japan all holding monetary policy meetings. None of the banks changed interest rates but that doesn’t mean there was nothing for investors to digest.
The Fed’s statement acknowledged that medium term inflation will gradually rise but gave nothing away on the timing of rate hikes. In our view, although wage growth slowed in January, the strong employment growth (227,000 jobs created) in addition to the stronger tone of recent economic news and relatively calm markets means that a rate hike is a live possibility for March. Presently investors seem unruffled by the prospect of this based on Fed funds futures which only imply a 24% probability of a March hike. But further ‘Fedspeak’ on a March hike could send bond yields and the dollar back on an upward trajectory following a more stable last few weeks.
In the UK, bond investors took heart from the fact that the Bank of England kept its inflation forecasts unchanged and on balance we continue to believe the Bank is more likely to tweak its QE policy than increase interest rates this year. Although the Bank of Japan raised its 2017 growth forecasts, it acknowledged downside risks to both growth and inflation so we don’t anticipate any major policy shifts in 2017.
Finally, investors seem more uncertain about the ECB’s future direction given the sharp rise in headline inflation from 1.1% in December to 1.8% in January. However core inflation (0.9%) remained unchanged at well below the ECB’s 2% target in January. During testimony to the European Parliament yesterday, President Draghi echoed comments from the ECB’s last press conference when he said that “there are no signs yet of a convincing upward trend in underlying inflation”. Consequently we continue to believe that an interest rate hike in the Euro zone is very unlikely this year while the next step in its QE taper very much depends on the evolution of growth an inflation dynamics in the region.
Tom McCabe, Global Investment Strategist – 7 February 2017