Trade and disinflation keep central banks dovish

Global central banks are in dovish, if not outright easing, mode, as they seek to maintain easy monetary conditions to counteract an uncertain trade outlook and disinflationary forces.

Global central bank rhetoric has turned even more dovish lately, encapsulated by the latest Federal Reserve (Fed) meeting and the European Central Bank (ECB) policy forum in Sintra, both in June. With global manufacturing slowing and inflation failing to pick up much, the Fed has signalled clearly that its next move might be a rate cut, ending a period of neutral ‘wait and see’. ECB President Mario Draghi has put further easing on the table for September unless the euro area economy improves in the meantime.

Here, we present a summary of our near-term forecasts for various central banks.

US Federal Reserve. The Fed has signalled its next move could well be a cut, even though it sees the domestic economy as resilient and does not expect a recession. This means any move to lower rates would be “insurance” cuts mimicking those of 1995 or 1998. Bottom line is that the Fed’s increasing role as a “political backstop” (i.e. as a counter-force to Trump’s erratic and uncertain trade policy), and the focus on inflation expectations, mean that there is a risk we see even more than the two 25 bps insurance rate cuts we expect in our central scenario in the coming months.

European Central Bank. We now expect the ECB to adjust its forward guidance in July, stating that policy rates will remain at present levels “or lower”, at least through the first half of 2020, while the ECB’s September meeting could be the venue for more stimulus. We forecast a 10bp cut in the ECB’s deposit rate in September, bringing it down to -0.50%. On balance, we believe it more likely than not that we see the ECB resume asset purchases by next year. Christine Lagarde’s nomination as head of the ECB is unlikely to alter the bank’s fundamentally dovish policy in the medium term.

Swiss National Bank. We believe that the SNB will be reluctant to cut rates in direct response to any ECB move, especially if the latter goes for a small 10bp deposit rate cut, as we expect. The SNB’s first line of defence is more likely to be FX market interventions to counter any appreciation of the CHF. Only if FX interventions prove ineffective would the SNB resort to a rate cut.

People’s Bank of China. The PBoC started its current easing cycle in Q2 2018 as the Chinese economy decelerated amid rising trade tensions with the US. The central bank injected liquidity into the financial system through four successive cuts (totalling 350 bps) in banks’ reserve requirement ratio. This has led to a significant decline in short-term interest rates in the interbank market. The PBoC could remain accommodative, with further reserve requirement cuts on the cards in the months ahead. However, we do not expect the PBoC to conduct massive monetary stimulus. While aggressive deleveraging is no longer a policy priority, elevated debt levels in China remain a constraint.

Bank of England. The BoE has yet to formally remove its medium-term hawkish bias, but we think this may happen in the coming months as other central banks ease policy further. We continue to believe that in the event of a no-deal Brexit on 31 October (a scenario to which we assign a 30% probability), the BoE would ease policy massively, despite its warning that rate hikes could come in such an eventuality.

Bank of Japan. Prior to the recent dovish U-turns at other major central banks (led notably by the Fed), the BoJ had the most accommodative policy stance of any. We believe the BoJ intends to maintain an extremely loose monetary policy given weakening growth and sluggish inflation, it has limited options. In addition, the BoJ’s latest assessment of the domestic economy is still fairly upbeat, despite the external uncertainties, suggesting that it is not ready to make any policy moves in the near term. All in all, we expect the BoJ’s current policy framework to remain unchanged until at least mid-2020.

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