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Major Divergences: ECB Says No Hikes in 2022, Fed Sees 3 Hikes, BOE Hiked Today

In huge central bank divergences the Fed, ECB and Bank of England all part ways. I explain what's going on.
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I'm Smiling Lagarde

Surprise of the Day 

In the surprise of the day, the BOE Hiked Rates by 0.15 Percentage Points to 0.25 percent. 

The Bank of England became the first of the world’s major central banks to raise its benchmark interest rate since the pandemic began, while the European Central Bank said it would phase out an emergency bond-buying program while ramping up other stimulus measures to keep the 19-nation eurozone’s recovery on track.

Fed officials on Wednesday set out plans to accelerate the withdrawal of stimulus and signaled they expect to raise interest rates three times next year, a major policy pivot that reflects heightened concern about the potential for inflation to stay high. 

The shifts show how central banks’ plans to phase out multitrillion-dollar stimulus policies and move toward higher interest rates are playing out at different speeds in the world’s big economies, which are struggling with incomplete recoveries at the same time as inflationary pressures mount.

“I don’t think that something happening at the Fed is bound to happen” in Europe, ECB President Christine Lagarde said at a news conference on Thursday. The U.S., the U.K. and eurozone economies are at different phases of the economic cycle, and received different levels of government support during the pandemic, she said.

ECB Outlook - What? No Dot Plot? 

ECB December 16 2021 Outlook

Comments From Eric Dor

Eric Dor, Director of Economic Studies at IESEG School of Management  pinged me with his comments this morning via Email (emphasis mine).

The low officially expected inflation for 2023 and 2024 allows the ECB to justify its commitment to maintain some asset purchases until at least 2024, even if they will be conducted at a lower pace. Indeed the principal payments from maturing securities purchased under the exceptional programme, to be discontinued, will be reinvested until at least the end of 2024. The reinvestment horizon has thus been extended since it was 2023 before the meeting. Net asset purchases under the main programme APP will be maintained for as long as necessary at a monthly pace of €20 billion after a temporary increase, without any predetermined horizon. Hawks are reported to have disagreed, but were a minority. Any increase in the policy rates is thus deferred to an undetermined horizon, since the ECB has committed to exit from the APP shortly before it starts raising the key interest rates. The deposit facility rate is thus kept at -0.5% even if inflation has increased to 4.9% in the euro area as a whole! 

The official inflation forecasts have thus provided the governing council of the ECB with a narrative allowing to keep a very accommodative monetary policy, maintaining some sovereign bonds purchases to compress long term rates and try to assure the solvability of overindebted countries. This implicit fiscal dominance is thus going to last. Even if the ECB must avoid admitting it officially in view of its mandate, reducing the spreads is an implicit policy objective. Today the ECB has mentioned that in the event of renewed market fragmentation reinvestments can be adjusted flexibly across countries. The ECB has to avoid a new sovereign debt crisis in the euro area, with dramatic consequences on financial stability.

Now it is highly plausible that excessive inflation is going to be much less temporary than officially expected. At the same time asset price bubbles are going on to inflate, particularly on the real estate market. The monetary authorities will be quickly under pressure. The ECB has bought time again, until when?

Baby Steps, You Take Those Cutest Little Baby Steps

  • BOE Hikes by 0.15 Percentage Points
  • Fed Reduces the Rate of Asset Sheet Expansion Despite Roaring Inflation
  • ECB Will Keep Asset Purchases Going Until 2024

The central banks all say they "monitor things closely and take appropriate actions but that's always been a lie. 

In practice, they do what they want and make excuses why. The Fed committed to expanding it balance sheet into 2022 and inflation be damned will do just that. 

How Bad are Inflation Models, Expectations, and Forecasts vs Reality?

Inflation Models and Forecasts

What's Going On?

What's going on should be pretty obvious. Despite roaring inflation, central banks will say anything they want to justify the actions they decide to take.

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This above diagram explains what you need to know. Central banks believe in their models more than anything else, no matter how bad their models prove to be in practice.

For more discussion, please see How Bad are Inflation Models, Expectations, and Forecasts vs Reality?

Statements by the ECB, Fed, and Bank of England all reflect decisions they committed to, sometimes long ago. 

In turn, those commitments are based on their less than useless models as well as a universal fundamental belief that 2% inflation is a good thing. 

Dot Plot of Fed Rate Hike Expectations

Dot Plot of Rate Expectations 2019-09

The Fed Expects 6 Rate Hikes By End of 2023 - I Don't and You Shouldn't Either

How many rate hikes are coming? The Fed thinks 6 by the end of 2023. I am unconvinced the Fed gets in any hikes in 2022 and certainly not 6 by the end of 2023.

These ridiculous predictions assume there will not be another recession in "the longer run". 

Central banks like to pretend they will hike, but by the time comes, they have delayed so long they find an excuse to no do so. 

Possible excuses: A recession, stock market plunge, another pandemic, global warming, global cooling, or an asteroid crash. 

Central banks will find some excuse to delay hikes. But the most likely excuse is a recession or stock market crash. 

For discussion, please see The Fed Expects 6 Rate Hikes By End of 2023 - I Don't and You Shouldn't Either

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