Week Ahead: 13 December 2021

It is going to be a central bank meeting bonanza in the week ahead, with no less than 5 major central banks deciding on monetary policy.
 

 
The Federal Reserve is likely to announce it will wrap up bond purchases sooner than expected at its meeting next week, especially in light of another strong inflation print on Friday.

There was an interesting initial reaction to the latest US inflation report, which showed consumer prices rose to their highest level since 1982. Although the data was more or less in line with what analysts were expecting, the fact that dollar sold off and stock index futures rose in the immediate aftermath of the report suggests investors were relieved prices ‘only’ rose 0.8% on the month to take the headline CPI to 6.8% year-over-year from 6.2% previously.

It appears as though Thursday’s warning by the White House that this latest inflation report wouldn't reflect the recent drop in energy prices had some worried that we may even see 7% inflation.

So, the reaction was more a relief than anything else that inflation was not even hotter.

Still, this does little to change the outlook for interest rates in the US and it is the last major release for the FOMC to take into account before their meeting next week. In that meeting, the Fed is widely to announce the end of its asset purchases by March. This would then open the door to a rate rise around the middle of the year.

Today’s CPI data has cemented expectations that the Fed will indeed wrap up its bond purchases in the next couple of months, before raising interest rates in the first half of 2022.   

With the Fed likely to speed up the pace of taper, while most other major central banks are relatively less hawkish – not least the ECB and BOJ – this should keep the Dollar Index’s uptrend intact for a little longer at least.
 

 
The market has been pricing out the probability of a rate hike by the BoE, amid the latest Covid restrictions under the “Covid Plan B” strategy being implemented in the UK. This explains why the pound has struggled recently. The No. 10 party row is also weighing on sentiment, with Labour calling for Boris Johnson to resign if the prime minister is found to have misled MPs about the three parties that took place last year, which are being investigated for Covid rule breaches. But the pound’s recent weakness is more to do with worries about the economic impact of the steps the government has taken to stem the spread of omicron, even though there’s growing optimism that the variant is not as bad as first feared. That being said, although vaccine makers have provided us with some good news in recent days, the World Health Organisation (WHO) will likely wait until a couple of weeks for some detailed findings before providing its view. Once we hear from the WHO then the UK, and governments elsewhere, will probably respond appropriately.

But for as long as restrictions remain in place, this should weigh moderately on economic activity – and rate hike expectations. Some analysts, such as those at Goldman Sachs, now think that the BoE will delay its first rate hike to February. As such, the GBP/USD could be heading towards the next psychological level at 1.30 soon. But if the pound manages to halt its decline, its best bet would be against currencies where the central bank is less hawkish than the BoE – such as the euro or franc.
 

 
The European Central Bank, like the Fed and BoE, is also faced with rising inflation rates in the Eurozone. But the ongoing spread of Delta, couple with the new threat of the Omicron variant, means it will most likely do nothing at this meeting as policymakers assess the potential economic damage of tighter restrictions that have been introduced in parts of the region to combat the spread of coronavirus.

The ECB has already indicated it is phasing out its Pandemic Emergency Purchase Programme (PEPP) in March. The question as to whether it will then simultaneously boost its existing Asset Purchases Programme (APP) remains unanswered. The ECB will not want to create a cliff edge effect by abruptly reducing total QE by €60bn per month. So, instead, what we might see is a rise in APP purchases to provide a buffer, which will then likely be tapered later in the year.

In so far as Thursday’s decision is concerned, well it will probably use the excuse of coronavirus to keep current settings unchanged. The ECB may choose to postpone a decision on officially ending PEPP, and what other measures it will take, until its February meeting. By the time the ECB meets, the EUR/USD may have already dropped to 1.10, if the Fed was indeed hawkish the day before.
 
 

 
The world’s most boring central bank, otherwise known as the SNB, is again highly unlikely to make changes to its monetary policy when its policy meeting concludes first thing Thursday morning.  Switzerland is likely to face more pain in the coming months and quarters as supply chain bottlenecks, inflation and pandemic restrictions persist in many parts of the world. But the rising franc against the euro is making an SNB intervention in the FX markets more likely than any tweaking of monetary policy.
 

 
The Bank of Japan will be the last of the major central banks to make a decision on monetary policy on Friday. However, Japan’s benign inflation outlook means the central bank won’t have a decision to make. I can almost guarantee that it will leave policy settings on hold. This should keep the yen under pressure.