Central banks feeling the pressure

Strong inflation prints, ongoing supply chain bottlenecks, labour shortages, and further increases in commodity prices continued to stoke inflation concerns in October. Short-term yields rose sharply as investors bet central banks will have to raise rates sooner and faster if they are going to be able to rein in inflation. For their part, policymakers stuck to the view that current price pressures will fade over time though they stand ready to act if that doesn’t prove to be the case. We think the key question shaping up for 2022 is, can central banks continue to hold rates low until economies fully recover, or will inflation concerns force them to act more conventionally and raise rates in advance?

The BoE certainly appears to be in the latter camp, indicating rate increases are likely in the coming months after a close call not to raise rates in November. We now look for hikes in December and February but think market pricing for Bank Rate to hit 1% by the end of next year looks too high. The BoC has committed to not raising rates until economic slack is absorbed but arguably wavered on that in October when it opened the door to earlier hikes despite downgrading its growth projections. We now look for three rate increases in 2022 beginning in April—again not as aggressive as markets are pricing. The Fed continued to emphasize it wants to achieve maximum employment before raising fed funds but received plenty of questions on how it would handle conflicting inflation and employment objectives.

Markets are pricing in rate hike next year by the ECB and RBA though we don’t expect a move from either at this stage as they reduce QE programs in 2022. Markets have easily digested tapering announcements by other central banks with yield curves generally flattening as higher policy rates are seen capping inflation and slowing medium-term growth.

Highlights:

• The BoC seems to be putting more stock in strong employment data than soft GDP readings, and brought forward its estimate for when economic slack will be absorbed next year. That opens the door to an earlier rate hike and we now expect three rate increases next year beginning in April.
• The BoE also lowered its GDP forecasts in November but nearly raised rates amid an improving labour market, rising wages and inflation concerns. We now look for hikes in December and February, after which the BoE should start shrinking its balance sheet through reduced reinvestment.
• US GDP growth slowed in Q3 but payrolls are looking better and both wages and inflation are running hot. The Fed will begin tapering its QE program later this month, winding down net purchases by mid-2022 which should set up for a rate hike by the end of next year.
• Euro area unemployment is back to its pre-pandemic level but a sizeable shortfall in hours worked is keeping a lid on labour costs. The ECB continues to push back on rate hike expectations and we don’t see its policy rate moving higher next year.
• Strong inflation data and global central bank trends put pressure on the RBA’s yield curve control policy which it abandoned in early-November. That opens the door to earlier rate hikes and we expect a move in early-2023.

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Josh Nye is a senior economist at RBC. His focus is on macroeconomic outlook and monetary policy in Canada and the United States. His comments on economic data and policy developments provide valuable insights to clients and colleagues, and are often featured in the media.

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