Still further to go: the long road back to monetary normality
The Bank of England has followed the ECB in leaving rates unchanged
Caution remains the default option for central banks. With a backdrop of multiple variables and market noise it is difficult to predict what will happen in the next few quarters - let alone over the central banks’ forecast horizon. A lack of conviction and the interplay of international risks, along with fears of spooking financial markets, all combine to restrain major central banks from making bold moves.
Following the slew of disappointing data in Europe - largely blamed on the “Beast from the East” weather phenomenon - the Bank of England and the European Central Bank are both in “wait-and-see” mode.
In the UK, after the disappointing first quarter gross domestic product figures, as well as the notable slowdown in inflation, the Monetary Policy Committee left the Bank Rate unchanged in May, as we expected.
Should inflation fall more by than expected and if activity fails to rebound in the second quarter, the MPC may feel no need to raise the Bank Rate this year.
In the Eurozone, the ECB struck a cautiously optimistic tone on growth and inflation. Its guidance remained unchanged. Despite trying to project a balanced tone, we think the highlight on more prominent external risks points to a cautious approach. As with the Bank of England’s MPC, we think the ECB wants to buy time to see how the story unfolds in the second quarter.
Although a wind-down of the ECB’s quantitative easing program is broadly expected, it is reluctant to commit on the potential timing and technical details. We will hopefully get more clarity at its June meeting when a new set of macroeconomic forecasts are issued.
Across the Atlantic, the Federal Open Market Committee (FOMC) kept its policy rates unchanged in May. The tone of the announcement was balanced but markets interpreted the position as indicating a slight reduction in the likelihood of interest rate increases in the near future. It would appear that the FOMC acknowledges that inflation is going to run above target but that it will exercise some tolerance.
Again, the conclusion is that US policy normalisation will remain gradual despite the potential of an inflation overshoot.
Interest rates are still well below pre-crisis levels despite a persistent recovery in economic growth. It is clear that central banks are edging toward an exit from ultra-accommodative monetary policy - but it is a long and slow journey.