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.
Janet Mui, CFA is the global economist at Cazenove Capital, the wealth management division of Schroders. Janet is responsible for the formulation and communication of Cazenove’s top-down views. She is a member of the investment committee that oversees strategic and tactical asset allocation at Cazenove. Janet is also the macro spokesperson and a regular commentator at major media outlets including the BBC, Bloomberg and CNBC.
This article is issued by Cazenove Capital which is part of the Schroder Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements. All data contained within this document is sourced from Cazenove Capital unless otherwise stated.