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#Market Strategy — 28.08.2018

Jackson Hole: Central Banker Meeting And Monetary Policy Update

Edouard Desbonnets

Jackson Hole brought no major change in central banks policies. Central banks are tightening their policies at very different speed.

Anecdotally, Jackson Hole, Wyoming, is famous for the Snake River which attracts fly fishing fans. Paul Volcker, a fishing enthusiast and chairman of the Federal Reserve (Fed) at the time, was lured in 1982 and attended what was to become a major annual meeting of central bankers from around the world, economists and the financial press.

This year's theme, Changing Market Structures and Implications for Monetary Policy, is as always very academic. However, the symposium is taking place this time in a new geopolitical context, between trade tensions, the crisis in some emerging countries and President Trump's open criticism of the Fed's monetary policy. This offers a good opportunity to review our central banks outlook.

The Fed

The Fed was the first to initiate a more restrictive monetary policy (first rate hike in December 2015), which is logical given that its economy is more advanced in the cycle. With growth above potential and unemployment at an all-time low, inflation, now under control, could surprise to the upside tomorrow. Powell (Fed Chairman) stressed this risk at Jackson Hole, but said he did not see any risk of overheating the economy at the moment.

In fact, Powell replied to Trump, without naming him, that he intended to continue the rate hike cycle. Indeed, just recently the Fed faced open criticism from President Trump, who, six months after appointing Powell, then publicly accused him of not helping by raising rates. This interference was not appreciated by the markets because it touches on the Fed's principle of independence, but Trump, who is mid-campaign, is already pointing the finger at the Fed as being potentially responsible for the next crisis. The Fed does not intend to give in to pressure from the White House and Powell plans to raise rates in September because the state of health of the economy justifies it. The market also largely anticipates a 25 basis point increase in key rates at that meeting.

The market is more divided on a rate hike in December, as are the Fed members themselves. Some advocate raising rates in anticipation of a resurgence of inflation. Others think that it is necessary to pause in order to avoid an inversion of the yield curve, an uncomfortable situation where short-term interest rates become higher than long-term interest rates, which often heralds a recession 11 months later.

Given the strength of the US economy and the dynamism of the labour market, we are on the side of those who expect rates to rise again in December. We also believe that the Fed could raise rates twice more next year to 3%. This would then mark the end of the monetary tightening cycle and coincide with a decline in economic growth.

As for the quantitative policy, the Fed had already announced a plan to reduce its balance sheet, which would be done at a gradual and pre-announced pace and would be, according to the former president of the New York Fed, as boring as “watching paint dry”, in other words, without major impact on the markets. This is certainly not the opinion of certain emerging countries, which declared themselves victims of the tightening of dollar liquidity and were forced to raise their key rates during the summer to avoid capital flight. This revives the debate about the scope of the Fed: should it act only as the US central bank or should it care about the impacts it has on other countries? Members of Congress are split. In any event, and perhaps to avoid launching the debate, Powell made no mention of the Fed's balance sheet reduction at Jackson Hole.

The ECB

The ECB is phasing out its monetary stimulus programme now that fears of deflation have dissipated. Draghi was not at Jackson Hole, but he had already announced the ECB's roadmap in June: it will continue the asset purchase programme, at a rate of €30bn per month until September, then €15bn until December, before ending the programme. In addition to these amounts, the ECB keeps reinvesting maturing assets of around €10 billion per month. Next year, the ECB will continue to support markets, but only through reinvesting matured assets. We can estimate these amounts at €10-15 billion per month in 2019 and they should continue to be substantial in 2020.

Draghi plans to keep rates unchanged until “at least through the summer of 2019”. We therefore anticipate an increase in the deposit rate from -0.40% to -0.20% in September 2019, followed by a joint increase in the deposit rate to 0% and the policy rate to 0.25% in December 2019. It should be noted that three of the six members of the Executive Board, including its Chairman, will complete their terms in 2019, which complicates projections.

Bank of Japan (BoJ)

The BoJ is the last major central bank to continue a massive monetary stimulus. At the end of July, it confirmed its intention to continue along this path, in the absence of sufficiently sustained inflation. Interest rates will remain low for an extended period. However, the BoJ half admitted that its policy had negative side effects on certain segments of the economy such as banks and insurance, and created distortions in the markets. It is also now allowing itself more flexibility, both on its equity fund purchase programme (ETF) and on its policy of maintaining the 10-year rate at around 0%. The latter can be seen as a tiny step towards policy normalisation that the BoJ is taking and we do not expect any new decisions in the coming months.

Bank of England (BoE)

The Governor of the central bank confided that Brexit occupied 50% of his time and less than seven months before the date of withdrawal of the United Kingdom from the European Union, uncertainty still dominates. The rise in rates in August, 25 basis points to 0.75%, was anticipated by the market, but finally little understood because of the uncertainty surrounding it. The Monetary Committee justified it with good growth prospects and the increasing capacity utilisation. We no longer anticipate any interest rate increases in the coming months. The BoE may become more reactive as the fateful date approaches.