Market expectations around the future of monetary policy have fluctuated wildly over the last couple of weeks. But for the two major central banks in Europe, a consensus seems to have formed on what to expect from policy. Markets could still be rattled by what the monetary policy statements say and imply about the outlook, raising the risk of increased forex volatility on Thursday.
The ECB has been talking for months now about how inflation (and therefore monetary policy) is in a “good place”. There had been the threat of a rate cut at some point this year to head off a strong Euro amid improved economic growth and a weaker dollar. Now, that has switched in the other direction, as the threat of a prolonged war in the Middle East could mean crude prices stay elevated. Eventually, that would push up inflation, and the market his already reacting to that possibility.
Not Another “Temporary” Shock
The last time crude prices spiked in the wake of Russia’s invasion of Ukraine, central bankers came under fire for being slow to act to head off the subsequent jump in inflation. Fed Chair Jerome Powell was mocked for using the word “temporary”, but ECB President Christine Lagarde also used the term, and BOE Governor Andrew Bailey used similar rhetoric. Those central bankers might be quicker to react this time around, and that could put increased pressure on them to take a more hawkish stance. Certainly, the market seems to think so, as bunds and gilts rise ahead of the meetings.
On the other hand, the Bank for International Settlements (BIS) warned against being too quick to hike rates. Often described as “the central bank to central banks”, the BIS issued a statement at the start of a week where most major central banks hold policy decisions. It said that this was a textbook situation for “looking through” a supply shock, if it proves temporary. But that’s part of the problem for the central banks.
No One Knows What Will Happen, Including Central Bankers
It’s unclear at this point how long the war will last, and, perhaps more importantly, how long the supply shortage will persist and push up crude prices. In fact, central bankers are going into these meetings practically blind, since the situation now is radically different from February. And key data points such as job numbers, PMIs, CPIs, for the war period won’t be available until early next month.
This has left the consensus that both the BOE and the ECB will keep rates unchanged in a bid for time. What could affect markets is the extent to which they express concern about the impact of higher crude prices. If they give a “wait-and-see” statement, then markets could be left a bit adrift. If they talk about “risks being to both sides”, this could be seen as a more dovish and balanced perspective. If central banks warn about the potential for inflation, this could leave traders with the impression that hikes could be coming soon.
Currencies Fluctuate on Expectations
The pound has gained relatively recently, as prior to the war, the consensus was for a rate cut. Now it’s for a hold. Meanwhile, the ECB’s stance on holding is unchanged. For the BOE, the issue is whether its easing bias remains intact, while for the ECB, it’s whether it is likely to hike soon.
Another complication for the BOE specifically is that markets usually look at the vote split for clues about who is hawkish and dovish and where policy is going. But this time around, a large number of otherwise doves might vote to hold simply because they want to wait for more data, not because they’ve suddenly turned hawkish. That might jolt the pound in the aftermath of the rate decision.
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