Sat, Feb 04, 2023 @ 11:19 GMT
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Weekly Focus – Central Banks Take Centre Stage

Easing pandemic curbs and global recession fears continued to drive markets. Despite rising cases, China stepped up its easing of Covid-19 restrictions on a nationwide basis. Health authorities allowed the use of home quarantine for some Covid patients and test requirements will be scrapped for most public venues. A clear shift is taking place in official communication, with emphasis on economic recovery and the decreased severity of the Omicron variant. Chinese equities cheered on the news, however, sour risk sentiment and ‘rate fears’ weighed on US stocks. US yield curves inverted further and the 2s10s curve inversion is now at 84bp, a level only exceeded in 1978 and 1982, when Fed Chairman Volcker hiked policy rates aggressively to counter double-digit inflation, but also triggered two deep and long-lasting recessions. Despite the G7 Russian oil price cap and EU Russian oil ban coming into effect, oil prices continued to decline, reaching USD/bbl 77, the lowest level since December 2021. Bank of Canada hiked policy rates by 50bp, but signalled that this may have been the final rate hike for now. Canada is an interesting case, as it has been one of the frontrunners of the global rate hiking cycle in 2022, and we see a similar case for Norges Bank delivering its last 25bp hike at the meeting next Thursday.

Russian President Putin warned that his war is likely to become a long one. In a televised address, he said his invasion has already yielded ‘significant’ results and that he would not mobilise more troops. He also acknowledged that the risk of a nuclear war was growing, but insisted that Russia would only ever use nuclear weapons in response to an attack. Russia continued its attacks on Ukrainian critical infrastructure this week and European gas prices rose further, with the market not expecting any meaningful price drops in 2023, even outside heating periods, see twitter. A worrisome development for Europe’s industry, as cracks in economic resilience have already started to appear in Q4 (see also Euro Area Macro Monitor – Chilling prospects, 6 December).

A busy week awaits, with central bank meetings in focus. The stabilization in euro area core inflation in November, paired with the weakening growth outlook and stable inflation expectations probably gives ECB enough arguments to slow the hiking pace to 50bp at the meeting on Thursday. However, we expect it to continue guiding for further rate hikes ahead, paired with a reduction of the balance sheet (QT), as ‘stickily’ high core inflation could remain a concern for ECB for some time yet (see ECB Preview – A hawkish 50bp, 8 December). US CPI figures will set the tone for the Fed meeting on Wednesday. Despite signs of peak inflation, economic data continues to paint a strong picture of services activity and the US labour market, with high wage inflation. From the guidance of Fed officials, a 50bp hike seems a done deal, but with the recent easing of financial conditions, further rate hikes might be needed in 2023 (see Fed Preview – Tightening pressure persists into 2023, 8 December). We also expect Bank of England to revert to a more dovish stance and join the club of 50bp hikes. December flash PMI figures are also on the agenda for the euro area, UK and US on Friday and we expect them to bring further evidence of the rising recession risks ahead, while focus will also be on the strength of the labour market and further signs of easing input cost pressures. EU leaders will gather on Thursday to discuss a ninth Russian sanction package, funding for Ukraine and the contentious gas price cap.

Full report in PDF.

Danske Bank
Danske Bank
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