Updated scenarios for central banks, inflation and oil prices
This week’s announcements by major central banks suggest that their reaction function is diverging from our initial expectations, with inflation concerns trumping sensitivity about growth data and financial conditions. We are adjusting our forecasts for policy rates accordingly.
Federal Reserve. We now expect the Fed to hike by 50bp in July, followed by 25bp hikes at each of its subsequent policy meetings (September, November and December). There is the possibility the Fed tightens more than we expect in this updated scenario (for example, it could opt for another 75bp hike in July, with 50bp hikes per meeting thereafter). Consumer prices (and particularly food and fuel prices), wage growth and inflation expectations (including consumer-driven inflation expectations contained in the University of Michigan survey) will all be crucial to watch. We expect the rise in the headline consumer price index (CPI) to stabilise shortly at 8.0-8.5% year-on-year (y-o-y) before declining closer to 5% by year’s end. We forecast core personal consumer expenditures (PCE) inflation (the Fed’s favoured inflation gauge) to be close to 4% at the end of 2022.
European Central Bank. The ECB looks set to announce a new ‘anti-fragmentation’ tool at its July meeting, which could pave the way to accelerate monetary tightening, especially in view of persistent inflation. We expect the ECB to hike by 25bp in July, 50bp in September, 50bp in October, then 25bp in December, February, March, pushing the terminal rate to 1.5% by Q1 2023. We then expect the ECB to pause on the back of weaker growth and inflation in 2023. Recent oil price movements and May’s upside surprise in headline inflation mean we are revising our inflation forecast for the euro area, expecting price rises to peak in late Q3. More importantly, we now expect core inflation to rise above 4% before easing somewhat in Q4. Overall, we believe that there is a possibility of higher rate hikes in the near term (with an outside chance of a 50bp hike in the deposit rate in July), but also a chance that the ECB’s rate-hiking campaign stops earlier than has been expected.
Bank of Japan. There is a rising chance of some adjustment in the BoJ’s monetary policy easing over the next few months. One possible change could be to move the anchor point of its yield-curve control to a shorter maturity (for example, moving from fixing the 10-year JGB yield to fixing the five-year one instead, thus allowing long-term yields to move higher). Another near-term option would be direct interventions in the FX market. This would be a decision for the Ministry of Finance, but it would be implemented by the BoJ. While the timing of such interventions is difficult to predict, one likely will need to see much more frequent and urgent verbal warnings before any real action is taken.
Bank of England. We are raising our expectations for the BOE’s benchmark rate, which we now expect to peak at 2.0% by November 2022. After the 25bp rise in the bank rate on 16 June, this means additional rate increases of 25bps at each of the BOE’s next three meetings. However, given the challenging growth backdrop facing the UK economy, the bank rate could plateau sooner.
Swiss National Bank. Having raised its policy rate by 50bps to -0.25% on 16 June, we now see the SNB hiking the rate by a further 50bp in September and then by 25bp at each quarterly meeting until at least March 2023, bringing it up to at least +0.75%. Risks are tilted towards bolder moves, depending on the exchange rate and policy actions by other central banks.
Oil prices. With Russian oil supply missing from the equation and US demand strong, tension in the oil market is likely to persist during the northern hemisphere summer. Two opposing forces will largely determine global oil demand. On the one hand, western economies are expected to slow in H2 due to the energy shock and tighter financial conditions. On the other, China is reopening after covid lockdowns, which could boost commodity demand. All things considered, we have decided to raise our forecast for Brent price prices, which we now expect to remain at USD120-USD130 per barrel during the summer. We then expect prices to settle at USD110 by the end of the year (compared to our previous forecast of USD95).