Cooling US Inflation Lifts Hope for Smaller Fed Rate Hike

Summary:

Slowing inflation and a cooling property sector are fuelling expectations that the United States central bank can adopt a smaller interest rate hike this week, as policymakers assess current efforts to rein in prices.

As consumer inflation rocketed to decades-high levels last year, the Federal Reserve raised rates seven times in an aggressive campaign to cool the world's biggest economy and lower costs.

Since then, the interest-sensitive property sector has slumped, retail sales have weakened and wage growth has started to ease, prompting some Fed policymakers to suggest it may be time to slow the pace of rate hikes further.

"A slower pace of rate hikes will give the committee time to assess the full economic effects of monetary tightening thus far," said Moody's Investors Service in a report.

Markets expect the Fed to adopt a 25-basis-point hike at the end of a two-day meeting on Wednesday, slowing the pace of increases for a second time in a row.

This would take the benchmark lending rate to 4.50 per cent to 4.75 per cent, a level last seen in 2007. In December, the Fed announced a 50-basis-point hike, stepping down from four earlier, steeper spikes.

"They are seeing the desired effects of policy," Rubeela Farooqi of High Frequency Economics told AFP.

"They don't want to keep on pushing until they get the economy into a recession," she said.

"Far from won"

But the inflation fight "is far from won", warned the Moody's report.

Although demand appears to be moderating and supply bottlenecks have eased, spending has been stronger than expected.

This has prevented inflation from falling more rapidly and suggests that the Fed's "terminal rate" - the level at which it will halt its increases - remains uncertain.

For inflation to come down to the Fed's target, "we will need a little bit of softening in the labour market", Madhavi Bokil of Moody's Investors Service told AFP. This could show up in a slower pace of hiring and fewer vacancies.

Wages do not appear to be driving inflation up, but they do lend some support to consumer spending as households draw down on COVID-19 pandemic-era savings.

Salary gains remained high last year, while employers were reluctant to shed workers they may have struggled to find since the pandemic, keeping the labour market tight.

"Soft landing"

On the other hand, the fact that the labour market has not slumped in response to tightening monetary policy brings optimism for a "soft landing" of the economy, where inflation comes down without triggering significant job losses or a major downturn.

"No one ever said that arranging a soft landing is easy, but our base case remains that if the Fed stops raising rates soon, the risk of a severe recession is quite small," said Ian Shepherdson of Pantheon Macroeconomics.

If the Fed raises rates too far, a "bigger danger" would be an unnecessary recession, he said.

"However much the Fed might want to be sure the inflation demon is put back in its box", dragging inflation below policymakers' 2 per cent target and an "accompanying rise in unemployment would represent a policy failure", said Shepherdson.

Source: AFP

Risk Warnings and Investment Disclaimers

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China to Boost Economic Rebound, Stabilize Foreign Trade, Investment

Samantha Luan

Economic

China will consolidate and expand the momentum of economic rebound, accelerate consumption recovery and stabilize foreign trade and investment, according to the decisions made at the State Council executive meeting chaired by Premier Li Keqiang on Saturday.

Noting the continuing trend of economic recovery and rebound, the meeting stressed the need to implement the decisions of the Central Economic Work Conference and focus on ensuring stability in growth, employment and prices, to keep the economic performance within a proper range.

Solid steps will be taken to ensure effective implementation of the policy package for stabilizing the economy and its follow-up measures. Key projects and equipment upgrading and renovation supported by fiscal and financial policy tools will be advanced to generate more physical gains.

Policies to extend the duration of VAT relief for small-scale taxpayers and inclusive loans granted to micro and small businesses will be effectively implemented.

It is imperative to remain firmly committed to consolidating and developing the public sector, and to encouraging, supporting and guiding the development of the non-public sector, to protect the lawful rights and interests of private businesses and foster a market-oriented, world-class business environment governed by a sound legal framework. The platform economy will be supported in pursuing sustained and sound development.

The meeting underscored the need to facilitate a speedy reopening of businesses and production after the Spring Festival and to provide good services for migrant workers in returning to their work or landing new jobs.

"We need to step up efforts to deliver on the policies for expanding consumption," Li said.

Noting the pressing challenge of lackluster demand, the meeting urged timely measures to promote an early recovery of consumption as the main economic driving force, steadfastly advance opening-up, and stabilize and upgrade foreign trade and investment.

Consumption will be further boosted. Policies for supporting consumer service businesses and self-employed individuals and promoting the consumption of cars and other big-ticket items will be fully implemented. Various activities will be launched to stimulate consumption and facilitate the early recovery of contact-based service industries.

Consumer loans will be increased as appropriate. The policy toolkit will be harnessed following a city-specific approach, to meet people's basic housing needs and the need for improved housing conditions and ensure the delivery of pre-sold homes.

"Boosting consumption is a key step to expand domestic demand. We need to restore the structural role of consumption in the economy," Li said. "The greatest potential of the Chinese economy lies in the consumption by the 1.4 billion people."

The meeting reaffirmed China's commitment to the basic national policy of opening-up and called for more concrete measures to stabilize foreign trade. Efforts will be made to promote the resumption of in-person exhibitions at home, and support enterprises to participate in exhibitions overseas.

Policies concerning export rebates, credit loans and credit insurance, among others, will be earnestly implemented, and the RMB exchange rate will be kept generally stable at an adaptive, balanced level. Enterprises will be supported to further explore market opportunities by making full use of the Regional Comprehensive Economic Partnership (RCEP).

Development of cross-border e-commerce and overseas warehouses will be further promoted. The competitiveness of foreign trade will be enhanced. Import will be expanded as appropriate.

Active efforts will be made to attract foreign investment. The new Catalogue of Encouraged Industries for Foreign Investment will be put into effect at a faster pace. Local governments will be supported in attracting businesses and investment. The role of pilot free trade zones and other platforms will be better leveraged.

Facilitative measures on cross-border travel will be earnestly implemented. Sustained efforts will be made to improve services for foreign-invested enterprises, and promote the earlier delivery of major projects.

"We must fully leverage our competitive advantages, improve our business environment and stabilize foreign trade and investment by opening wider to the world. Opening up is in China's fundamental interests," Li said.

The meeting urged relevant departments to make comprehensive plans in early February and ensure a greater sense of responsibility at all levels to promptly start spring plowing and farming preparations, in order to lay a solid foundation for bolstering food supply and stabilizing consumer prices.

Source: China Daily

Risk Warnings and Investment Disclaimers

Should Reducing Inequality Be a Central Bank Mandate?

Justin

Central Bank Economic

Traditional monetary theory holds that central banks are guided by a mandate of protecting price and financial stability. In the case of the US Federal Reserve, the dual mandate holds that it must maintain equilibrium inflation and unemployment, adjusting interest rates to maintain that equilibrium. Yet an emerging chorus of economists and policy-makers are making the case that an equality objective should be a component of central banks’ monetary policy responsibilities.

Such a concept would have been almost inconceivable only a decade ago. In 2021, however, Senator Elizabeth Warren, Representative Maxine Waters and Senator Kirsten Gillibrand proposed the Federal Reserve Racial and Economic Equity Act. As Warren put it, ‘The Fed can use its existing authorities to help reverse the serious racial gaps in our economy, including in our current recovery from the Covid-19 crisis - and our bill will require the Fed to do so.’

The bill was passed by the House of Representatives but died in the Senate. Yet it remains a notable moment in growing attempts to explore US inequality and the possibility of monetary policy as a part of the solution. Figure 1 shows that central bankers are discussing inequality with greater frequency. In 2004, inequality was mentioned in less than 1% of speeches by central bankers in both emerging and advanced economies. In 2021, that figure was over 9%.

Figure 1. Central banks increasingly focused on inequality

Share of central bank speeches that mention inequality

Should Reducing Inequality Be a Central Bank Mandate?_1

Source: OMFIF analysis, Bank for International Settlements

Why is there such newfound interest in discussing economic inequality? Part of it may have to do with the considerable growth of inequality in many advanced economies since the 1970s (Figure 2). From 2009-12, the top 1% of US earners captured 91% of total growth, according to data collected by Emmanuel Saez, professor of economics at the University of California, Berkeley. The aftermath of the 2008 financial crash coincided – to no one’s surprise – with a souring of the public’s attitude to the failed trickle-down economic dictums that characterised the politics of the previous 20 years in both the US and the UK.

Figure 2. Inequality has grown considerably in advanced economies

Gini coefficient 1970-2015, 0-100 (highest inequality)

Should Reducing Inequality Be a Central Bank Mandate?_2

Source: OMFIF analysis, Bank for International Settlements

Many economists (including those at the European Central Bank, Fed and Bank of England) believe that central banks’ use of near-zero interest rates and quantitative easing in the aftermath of the 2008 crash worsened wealth inequality. Lower- and middle-income households have limited access to financial markets and equity investment opportunities, in large part because their marginal propensity to consume each dollar of income is greater than high-wage individuals. And so, a loose monetary policy that spurs asset equity market growth tends to kindle wealth inequality since it chiefly benefits wealthier asset owners.

Central banks argue that the benefits of such policies outweigh these costs, but the recognition of the disequalising impacts of post-2008 policy helps explain why central banks are being asked to address inequality in their monetary policy. Moreover, any relationship between interest rates and inequality may be self-reinforcing. In 2021, Atif Mian, Ludwig Straub and Amir Sufi showed that rising income inequality played a principal role in explaining the decline in real interest rates in the US. In 2022, BoE Governor Andrew Bailey echoed this conclusion at an OMFIF event.

What would it look like for central banks to include inequality as a component of their mandate, alongside price stability and employment? Given the already complex demands of balancing inflation and unemployment, answers to this are nebulous at best and there are competing theories for how it could be done.

Research by Tobias Broer et al and Carl Walsh offers an interpretation of a two-agent new Keynesian model, whereby the economic universe is delineated by capital owners, who hold claims on profits but do not supply labour, and workers, who do not have a claim on profit but do supply labour. Such a model has implications for economists’ calculations of consumption elasticity and individuals’ forward-looking orientation towards their income. And such a delineation could, in theory, allow central banks to integrate inequality targets within their mandates.

Niels-Jakob Hansen, Alessandro Lin and Rui Mano build upon this by showing, in a Taylor model of central bank decision-making, that monetary policy could maximise welfare if it targets inflation, unemployment and output gaps while also placing a small negative weight on consumption inequality. This model can also offer an explanation for why real interest rates have been in decline, since disequalising shocks (such as skill-biased change and outsourcing) have induced inequality, which under this Taylor model would implore central banks to keep real interest rates lower than otherwise.

These results are endogenous to the model and there are inherent complexities of developing a central bank equality objective. The underlying assumptions of these theories are debatable, and the risk of miscalculation grows with the difficulty of accurately charting a countries’ time-varying wealth and income distribution. Moreover, the kind of ‘holistic’ approach such an objective might call for would make it more difficult for central banks to maintain consistency between leadership regimes and to set forward guidance. An equality objective may be beyond the scope of central banks’ core responsibilities.

This does not mean that central banks should ignore economic inequality when implementing their monetary framework, however. Although equality objectives may be difficult to implement, increasing awareness of inequality is not.

Central banks should take this further, using banking sector statistics to report on how inequality impacts the efficacy of their policies, and how their policies will impact inequality. Central banks should then take any disequalising effect into account when crafting their monetary responses, and they should articulate these impacts to the public and to legislators. Such an approach is similar to how central banks monitor international developments in assessing the outlook for the US economy.

Beyond this, however, central banks’ job should remain the imposing task of maintaining price stability and financial stability in the interest of maximising public welfare. The fair and efficient distribution of economic resources is a public good and central banks’ growing interest in discussing and reporting on inequality is a positive development that should be encouraged. But central bank policy is no substitute for effective social security, shock adjustment assistance and financial market regulation.

Moreover, a central bank’s political independence is particularly important to its functioning, especially in a moment of heightened polarisation and partisanship. A more holistic model that identifies inequality as a specific mandate could threaten to erode that independence and encourage more partisan behaviour. Such an outcome would be both economically hazardous and politically toxic – central bankers are unelected officials with no mandate to weigh into partisan policy debates beyond their monetary responsibilities.

Issues of economic inequality are thus principally issues of legislation, best left to elected officials that represent the will and interests of the public. Yet, given the clear relationship between monetary determinations and distributional outcomes, the emphasis by central banks on inequality as a consideration - but not a mandate - is an auspicious and badly needed development.

Source:Julian Jacobs

Risk Warnings and Investment Disclaimers

Why Biden Pushes an Assault Weapon Ban Despite the Political Odds

Alex

Political

Flags are lowered, sorrowful statements are issued, pleas to lawmakers are made, again.

In the wake of two mass shootings in California this week, President Joe Biden has followed a heartfelt and familiar script of outrage and grief over gun violence in America, coupled with a renewed call for Congress to pass legislation banning assault-style weapons.

Such a ban has little chance of passing the Republican-controlled House of Representatives or the Senate, which is narrowly controlled by Democrats, political experts say.

But Biden's stubborn strategy continues: make a ban the focus of public discourse whenever a mass shooting occurs and put pressure on lawmakers who oppose one. The White House hopes to build on already strong public support for stricter gun safety laws overall, and ultimately try to pressure Republicans in Congress into changing their thinking.

Janice Iwama, assistant professor at American University's Department of Justice, Law and Criminology, said that even if Biden fails to win a national ban, bringing attention to the issue could prompt some state legislatures to act.

"And it can happen a lot faster at the state level," Iwama said.

This week, after 18 people were killed over two days in California, the president asked lawmakers to send a bill to his desk as quickly as possible.

"It's really needed badly," he told Democratic leaders at a meeting on Tuesday. "We're going to ban assault weapons again," he said on Thursday at a Lunar New Year reception at the White House, to applause.

Republican opposition has not changed.

"There's not going to be any further legislative action there. We pretty much exhausted the possibilities a few months ago," Senator John Cornyn told Reuters.

The White House says Biden will not give up.

“The president’s strategy has been to make an assault weapon ban a winning issue so we can build a pro-gun safety Congress, and we’re making progress on that,” a second White House official said.

Biden's strategy may have longer-term political benefits going into the 2024 presidential election.

"I do suspect part of Biden's re-election plans over the next year is to try to contrast himself as a moderate, centrist, pragmatic figure versus the extremes," said Dante Scala, a political science professor at the University of New Hampshire.

Simple Math, Not Enough Support

A decade after 20 first-graders and six adults were killed in the Sandy Hook elementary school massacre, the U.S. federal government has put few limits on weapons like the high-capacity AR-15 used in the attack, or on the estimated 400 million guns in the country. Over 150 rounds were fired in just five minutes at the school, investigators said.

The recent shootings in California, which killed 18 people, show how even the strictest state laws can be ineffective thanks to a patchwork of federal regulation.

Biden has railed against assault-style weapons for years and repeatedly throughout his presidency. He was instrumental in getting a decade-long ban passed in 1994.

As vice president, he spearheaded a set of gun control proposals for Barack Obama after Sandy Hook that included a recommendation for a new assault weapons ban. None passed Congress, opposed by Republicans and the National Rifle Association lobby.

Last year, however, Biden signed into law the first major federal gun reform in three decades. It cracks down on overall gun sales to perpetrators of domestic violence and expands some background checks to juveniles.

These and even stricter measures have strong public support.

A June Quinnipiac poll showed nearly three out of four Americans support raising the age at which a person can buy a gun to 21, and 92 percent supported background checks for all gun buyers.

However the Quinnipiac and other polls show that just about half of Americans support an assault weapons ban.

To pass one, the president would need 60 votes in the Senate - nine Republicans and all 51 Democrats and independents - and a simple majority of 218 votes in the House of Representatives, which has 222 Republicans and a Republican speaker, who would have to consent to bringing a bill to the floor for a vote.

The June law won support from 14 Republicans in the House and 15 in the Senate, after mass shootings in Texas and New York killed more than 30 people, including 19 children at an elementary school.

The U.S. Constitution's Second Amendment protects the right to bear arms, and that issue is a hot button one for many Republicans, and backed by millions in donations from gun rights groups and manufacturers.

"Violent crime is on the rise and the people are anxious for solutions. But instead of setting an obvious course - like actually punishing the offenders or addressing our woefully inadequate mental health system - the President is attempting to resurrect an initiative that had zero effect on violent crime," said NRA spokesperson Lars Dalseide.

The White House points to statistics, including from University of Massachusetts researcher Louis Klarevas, that show gun massacres sank 37 percent and gun massacre deaths dropped 43 percent during the 10-year period of the assault rifle ban, compared to the previous decade.

Even though an all-out assault weapons ban seems unlikely, a very thin Republican majority in the House means that something more modest, such as raising the age to 21 to buy assault weapons, could be possible, the University of New Hampshire's Scala said.

Advocates say the White House has other options it can pursue to reduce gun violence even if Congress does nothing for two years, from executive action to budgeting to enforcement of existing laws.

Biden's team says it is cognizant of the political odds.

“Our job is to keep trying. The president is going to keep using the bully pulpit, keep pursuing executive action, keep building on the legislation he got done last summer," the second White House official said.

Source: Reuters

Risk Warnings and Investment Disclaimers

Outlook 2023: Housing Market Will Weigh On China’s Recovery

Justin

Reviving consumption and domestic demand is top priority

China has made domestic demand expansion – including consumption – the top policy goal this year, whereas last year government officials prioritised containing the virus. The consumption rebound in China will be real, albeit moderate relative to the Covid-19 consumer ‘boom’ in developed economies like the US. The readiness of households for ‘revenge spending’ as curbs are lifted is evident in rebounding cinema ticket sales in January and increased spending on tourism over the lunar new year, both domestically and overseas.

The revival of consumption should help China’s gross domestic product return to potential growth this year of around 5%, after official growth of 3% last year. This will boost global growth, but be significantly inflationary, given that China’s consumption revival will be real but not explosive.

There are four reasons for thinking that China won’t have a consumer boom to the same degree as the US: the design of its pandemic stimulus, its labour market, consumer confidence and the ailing housing market. During the acute phase of the pandemic in 2020-21, the US made huge transfers to households to support consumption demand. By contrast, China focused stimulus on companies and investment, only indirectly supporting households by giving employers tax and financial incentives to maintain payrolls. China didn’t suffer the same kind of mass lay-offs as the US early in the pandemic, but also won’t see the same labour shortages post-pandemic.

Unemployment has risen in China, especially among young people where it is around 17%. Migrant worker jobs are at risk too, with falling exports likely to depress factory jobs. But the offset is that reopening will boost service sector jobs and small- and medium-sized enterprises. The shift of migrant workers to service jobs closer to home has been a medium-term structural issue for manufacturing, leading to labour shortages in the pre-Covid-19 years.

Consumer confidence plunged in China in early 2022, as the Q2 lockdown in Shanghai and elsewhere dragged on. Households saw no end-point for tough restrictions under the zero-Covid policy, with variants becoming more contagious. Once China gets past the exit waves, consumer confidence should gradually rebuild. People will still worry about the economic outlook, but at least one major impediment – zero-Covid policy – is removed.

The housing market faces the prospect of slower recovery than consumption or broad domestic demand, which is a reversal of its usual role. Big cities and high-quality developers should see improving home sales from Q2 onwards, on the back of further policy support – for example, to incentivise upgrader demand. The hundreds of smaller cities will trail behind in a long procession of local market recovery cycles lasting several years.

Early signs of results in developer liquidity support policy appeared in the improvement in bank loan funding for real estate developers in late 2022. The plan is to boost liquidity for high-quality developers, so they can complete projects. This will increase buyer confidence in presale projects by high-quality developers, boosting their sales and thus access to finance. The bank regulators are reported to have given banks criteria to assess which developers are ‘high quality’. This market-based process will be slower than a broad bailout, but deflate financial risks by allowing issues with poor-quality developers to be resolved one way or another.

With this policy context, buyers are likely to be more picky about developers and markets. This means a slower recovery. At the same time, it is worth remembering that the zero-Covid policy has been a lodestone on the housing market too. Buyers are understandably reluctant to invest in a long-term asset in a market that faces the indefinite prospect of lockdowns and economic pain. Reopening should serve as a catalyst for housing sales in markets with fundamentally good supply-demand dynamics like upper-tier cities in the Yangtze River Delta and Pearl River Delta.

Source:Duncan Wrigley

Risk Warnings and Investment Disclaimers

Indonesia Wants More Than a Nickel for Natural Resources

Thomas

Energy

Indonesian Minister of Investment Bahlil Lahadalia suggested that Indonesia is looking into forming an OPEC-style cartel for nickel and other inputs used in battery production. Nickel is becoming a hot commodity as it is a key input in the manufacture of lithium-ion batteries needed for electric vehicles (EVs) - and Indonesia has the world's largest nickel ore deposits.

Given that demand for EVs is expected to balloon in the coming years, countries rich in natural resources are exploring the most expeditious ways to capitalise on the situation.

The idea for an OPEC-style cartel reflects the Indonesian authorities' desire to leverage its control over a scarce and highly sought-after commodity. They seek a more favourable position on the global technological frontier.

Indonesian officials are discontent with the relatively low-value activities of extracting and exporting raw commodities. They want more of the value added during processing and manufacturing. Such value has historically been captured outside of Indonesia.

This was the logic behind a series of recent nickel ore export bans - a strategy that catalysed billions of dollars of investment in Indonesia's downstream nickel processing industry. With mining and smelting activities increasingly localised, several leading global technology companies have made sizable commitments to invest in battery and EV production in Indonesia.

At least in the near-term, the decision to deprive global markets of unprocessed nickel ore achieved its objective of accelerating investment in higher value-added economic activities.

Talk is turning towards building on that success by scaling it up to the level of an OPEC-style cartel. This will allow Indonesia to exercise a greater degree of control over supply and price and maximise economic benefits.

Approach With Caution

It is early days and seems more like a trial balloon than anything, so there are reasons to approach such an idea with caution.

One reason the nickel export bans are working is because they are limited in scope and have a narrow, clearly defined objective - more downstream investment in Indonesian nickel smelters will lead to more investment in battery and EV production.

A global cartel of nickel-producing countries would be much more complex, difficult to organise and could be undercut at any time by a single member or simply by the vagaries of the market.

Not every nickel-producing country is going to have - or be able to achieve - the same objective. This could easily make any such undertaking unwieldy. Canada, a major nickel producer, has already indicated that it would be very unlikely to participate in any such scheme.

Another potential deterrent is that intentionally restricting supply to drive up prices incentivises actors to invest in developing alternative technologies. It would be a big gamble for Indonesia to assume that batteries will always be dependent on nickel.

If the price is too high and supply chains become excessively politicised, companies will start looking to develop batteries without nickel - a process that is already under way. An OPEC-style cartel risks accelerating this process while alienating trade and investment partners in the process.

The downside of alienating partners for short-term economic gain is also worth considering. Though Indonesia has nickel, it cannot manufacture batteries or EVs without the technology and know-how from mature industry players like China's CATL, South Korea's LG Group or Japanese automakers. Indonesia needs their assistance to move up the value chain as much as they need Indonesia's nickel.

Indonesia's Economic Nationalism

Resource-rich emerging markets like Indonesia have a long history of exploitation by more mature economies, particularly in extractive industries. Indonesia is asserting itself in a more muscular form of economic nationalism as a response, at least in part, to these historical imbalances.

This was evident in the blanket export bans on palm oil and coal in early 2022, as high global prices threatened domestic shortages. It is also evident in the way that Indonesia brushed off a World Trade Organization ruling that the nickel ore export ban violates Indonesia's commitments under the General Agreement on Tariffs and Trade.

The Indonesian government is not afraid to leverage its control over in-demand commodities to achieve important economic objectives. More than anything, Minister of Investment Lahadalia is sending a message about Indonesia's willingness to intervene in markets and buck the principles of free trade when it is in its national interest.

This is a message that should be listened to carefully and taken seriously. But trying to cartelise the global production and supply of nickel is a step too far and could easily turn into a case of taking a good hand and overplaying it.

Source: CNA

Risk Warnings and Investment Disclaimers

Four Bank of England scenarios for February's Meeting

Devin

Central Bank Forex

Four Bank of England scenarios for February's Meeting_1

The Bank of England looks more likely to follow the European Central Bank than the Federal Reserve next Thursday, and we expect a 50-basis point rate hike for the second consecutive meeting. While the minutes of the December meeting appeared to open the door to a potential downshift to a 25bp move in February – and this meeting looks like a closer call than markets are pricing – the reality is that the recent data has looked relatively hawkish.

Wage growth is persistently high, looking both at the official numbers and the BoE's own business surveys. Headline inflation came in a little lower than the Bank projected back in November, but services CPI – seen as a better gauge of domestically-driven inflation – has come in above expectations.

Still, if we get a 50bp hike on Thursday then it's likely to be the last. BoE officials have hinted previously that much of the impact of last year's rate hikes is yet to hit, and cracks are forming in interest-rate-sensitive parts of the economy. Headline inflation should begin to come down more rapidly from March too, as the impact of last year's energy bill surges drop out, and core goods/food pressure begins to ease more noticeably.

We expect one final 25bp hike in March, taking the Bank Rate to a peak of 4.25%. The key question for Thursday is whether the Bank itself acknowledges its work is nearly complete. We suspect it's more likely to keep its options open.

Here's what we expect:

The vote split

December's meeting saw the number of policymakers voting for a 75bp hike drop from seven to one, and the committee's two most dovish officials opted for no rate hike at all. The lesson then and throughout 2022 was that the committee tends to move by consensus, and that means that the vote split is unlikely to be particularly narrow, even if the meeting is a tough one to call. Either we'll get a similar number of officials voting for 50bp again, or we'll see the vast majority scale back their vote to 25bp, akin to the kind of shift we saw in December.

Our base case is that we see six of the nine policymakers voting for a 50bp hike, one for 25bp and two for no change.

New forecasts

Calmer markets and scaled-back rate hike expectations since the mini-Budget crisis last year mean we shouldn't be surprised to see the Bank upgrade its growth forecasts. Lower gas prices should theoretically help too, though this is a little more awkward for the BoE given that the government hasn't yet cancelled plans to increase household bills in April, even if such a move now looks unlikely. That also means we'll have to take the new inflation forecasts with a slight pinch of salt, and our own view is that headline CPI will end the year 1pp lower if April's planned increase is scrapped and consumer bills return to levels consistent with market pricing from the third quarter.

Still, it's the medium-term story that matters more. Keep an eye on the so-called 'constant rate' inflation forecasts, where the Bank assumes the Bank rate will remain unchanged from now on. If these show inflation at, or very close to, 2% in a couple of years' time, then that would be a sure-fire sign that policymakers think we're close to the peak for Bank Rate.

Guidance on future policy decisions

Governor Andrew Bailey hinted recently that current market pricing, which sees a peak for Bank Rate at 4.4%, is in the right ballpark. That suggests little reason for the Bank to rock the boat too much on Thursday with new forward guidance, and we suspect it will want to keep options open.

The Bank will likely repeat that it's prepared to act 'forcefully' in future if required (though we learnt in December's minutes that 50bp hikes classify as 'forceful'). We also doubt Bailey will be willing to be drawn on whether the Bank could pivot back to a 25bp hike in March, nor indeed whether that would be the last move in the cycle. Where he may be tempted to push back is on policy easing, especially now markets are almost pricing in one 25bp rate cut by the end of this year. Chief Economist Huw Pill's recent emphasis on the UK sharing the worst bits of the US and eurozone's inflation problems – structural labour shortages with the former, the energy crisis with the latter – feels like a line we'll hear a lot over the coming months as officials try to dampen expectations of policy easing.

Sterling rates to tighten to euro, and a more inverted curve

The sterling rates curve still trades with a remnant of the risk premium that appeared in the run-up to the September budget debacle, making it one of the few markets where we think rates are unjustifiably high. Things have changed since then, however. Markets have come around to our more benign view on the terminal rate in this cycle, now implying hikes will stop around 4.25%. Instead, the discrepancy is to be found in longer maturities where the curve implies the Bank rate will remain elevated longer than at other central banks.

Four Bank of England scenarios for February's Meeting_3

That markets taking a more hawkish view of BoE policy than signalled, for instance in its forecast, is nothing new. What's changed is the way participants look at inflation risk. This has prompted yield curves to take a much more benign view of Fed and ECB policy. Each country is different but we find the treatment of sterling rates increasingly at odds with that of the dollar and euro. As a result, we expect the differential between 5Y sterling and euro swap rates to shrink to 75bp. This convergence should also be helped by the worsening of UK economic surprise indices, just as their eurozone equivalent goes from strength to strength.

Four Bank of England scenarios for February's Meeting_4

We also think the GBP curve is due to flatten further. One likely driver is the market's growing confidence that the BoE, like the Fed, will soon be in a position to cut rates, although we wouldn't expect this before 2024. Another less probable driver would be if the BoE feels the need to tighten policy more than expected in the coming meetings. We very much doubt that longer rates would follow the short end higher, pricing instead a growing risk of rate cuts down the line to cushion the economic hit.

GBP: Temporary strength

The BoE's broad trade-weighted measure of sterling has bounced around 6% since the dark days of September and will marginally ease the BoE's fears of imported inflation. Given that a 50bp hike is not fully priced for Thursday, sterling could enjoy some limited and temporary strength should the BoE indeed hike 50bp. Depending on the post-FOMC state of the dollar, that could briefly send GBP/USD back into the 1.24/25 range and EUR/GBP back to the low 0.87s.

However, the challenges facing sterling have not gone away. Large twin deficits, weak growth and what throughout the year should be building expectations that falling prices – especially from March/April onwards – will provide room for the BoE to cut rates around the turn of the year.

In terms of a profile, we think a continued narrowing in GBP rates premium to the EUR can push EUR/GBP higher through the year towards the 0.90/91 area. GBP/USD should be supported by the better EUR/USD trend, but will probably struggle to hold any gains to the high 1.20s – potentially seen in the second quarter.

Source: ING

Risk Warnings and Investment Disclaimers

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Cooling US Inflation Lifts Hope for Smaller Fed Rate Hike

Source: AFP

China to Boost Economic Rebound, Stabilize Foreign Trade, Investment

Source: China Daily

Should Reducing Inequality Be a Central Bank Mandate?

Figure 1. Central banks increasingly focused on inequality

Source: OMFIF analysis, Bank for International Settlements

Figure 2. Inequality has grown considerably in advanced economies

Source: OMFIF analysis, Bank for International Settlements

Source:Julian Jacobs

Why Biden Pushes an Assault Weapon Ban Despite the Political Odds

Source: Reuters

Outlook 2023: Housing Market Will Weigh On China’s Recovery

Source:Duncan Wrigley

Indonesia Wants More Than a Nickel for Natural Resources

Source: CNA

Four Bank of England scenarios for February's Meeting

The vote split

New forecasts

Guidance on future policy decisions

Sterling rates to tighten to euro, and a more inverted curve

GBP: Temporary strength

Source: ING

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