Will the Fed give a hint on tapering its asset purchases?

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Will the Federal Reserve signal plans to taper its crisis-era bond buying?

The US central bank’s two-day meeting concluding on Wednesday will be top of mind next week for many investors who will be hunting for clues on when the Federal Reserve will begin tapering its $120bn monthly purchases of government bonds. 

In his August speech at the Jackson Hole symposium, Fed chair Jay Powell indicated that the central bank’s policy-setting committee could soon begin winding down its pandemic-era stimulus programmes on two conditions: “substantial progress” is made towards maximum employment and towards an average 2 per cent inflation rate. The inflation target has been met, Powell acknowledged, and the labour market is on its way. 

But employment figures in August were weaker than expected, which may stay the Fed’s hand for now.

“We expect the Federal Open Market Committee to open the door to a possible November taper announcement, conditional on a solid September employment gain. We believe the hurdle is roughly 750,000 [jobs added], which should be cleared fairly easily,” wrote analysts at Jefferies. 

Also in focus will be the Fed’s dot plot, a map of Fed officials’ expectations of where US interest rates will be over the next few years. The plot could be market moving, especially if expectations for the cycle of increases are brought forward.

Meghan Swiber, US rates strategist at Bank of America, said she expected the median dots for 2022 and 2023 to remain unchanged from June, reflecting increases beginning in 2023. But the dot plot will for the first time provide insight into expectations for 2024.

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“Our expectation is that they are going to show three additional rate hikes in 2024. The dots reflect FOMC participants’ base case so there’s actually some risk to this being more hawkish relative to market pricing,” said Swiber. Kate Duguid

How will the Bank of England react to a sharp rise in inflation?

Investors will be closely watching the Bank of England’s response to a surprise jump in inflation at its next policy meeting on Thursday. UK annual consumer price rises accelerated to 3.2 per cent in August — the highest inflation rate since 2012 — data last week showed, well above the BoE’s 2 per cent target. 

While the BoE policymakers had been predicting a surge towards the end of the year, the faster-than-expected pick-up will have raised eyebrows in Threadneedle Street. 

“UK inflation has surged to well above the rates that we, the market and the BoE had anticipated at the start of the year,” said Kallum Pickering, senior economist at Berenberg.

At its last meeting, the UK central bank signalled that a modest amount of tightening would be needed to contain inflationary pressures. Following the latest data, governor Andrew Bailey could indicate that the time for an interest rate rise is drawing closer by signalling that officials are comfortable with current market expectations, according to Steffan Ball, Goldman Sachs’ chief UK economist. Investors are expecting the bank rate will rise to 0.25 per cent by May next year from 0.1 per cent currently.

A hawkish signal from the BoE would likely give sterling a boost and push gilt yields higher. 

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With two new members joining the BoE’s rate-setting committee this month, including chief economist Huw Pill, Ball said it was likely that a majority of members now thought the minimum conditions for tightening policy had been met. 

“This news implies an earlier rate increase than we previously thought,” he said. Tommy Stubbington

What path will Scandinavia’s rate-setters take?

It is set to be a tale of two Scandinavian central banks this week.

Norway is on Thursday all but certain to become the first central bank of the G10 major currencies group to raise interest rates after the pandemic.

But two days earlier in Stockholm, Sweden’s Riksbank is forecast to keep its rates at zero and suggest they will remain there for years to come. In July the central bank suggested rates would be on hold until late 2024 at the earliest.

As James Pomeroy, economist at HSBC, wrote: “While central banks across the world are choosing to take very different views towards monetary policy, arguably nowhere in the world is that divide more evident than in Scandinavia.”

Line chart of Policy rate (%) showing Norges Bank is poised to raise rates as economy strengthens

Much of the difference stems from how the two central banks see their mandates and how they have performed in previous crises. The Riksbank is still scarred by prematurely raising rates in 2011 only to have to cut them again shortly afterwards. Its main target is 2 per cent inflation, and it has struggled to meet this for years so is reluctant to start increasing rates any time soon.

But Norges Bank has shown more flexibility and a greater focus on financial stability, particularly worrying about the strength of house prices. It raised rates in 2018 and 2019 before going from 1.5 per cent to zero in a few weeks at the start of the pandemic. The Norwegian economy is now performing strongly and the central bank wants to start to normalise policy.

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More interesting in the short term for the Riksbank is how it manages its balance sheet and when it might start to scale back its bond purchases. Still, most economists expect that to come next year at the earliest and the Riksbank to stand pat for now. Richard Milne



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