Sunset Market COmmentary

Markets

• The Istanbul Economic Forum, hosted by the Central Bank of Turkey, wasn’t on this year’s bingo list to make it into our Market Commentary. However, we give credit where credit is due as the CBRT assembled an impressive line-up of global central bankers. Timing is everything of course with the Forum coming amidst (diminishing) speculation on accelerated monetary policy tightening. We single out two. Heavyweight US Fed governor Waller discussed the economic outlook and the signaling value of the Summary of Economic Projections. With evidence that economic activity is strengthening in the second half of this year, he is not greatly concerned that tighter monetary policy threatens a damaging slowdown in the economy. But he is concerned that the recent acceleration in inflation—after what soon will be five and a half years of it above the FOMC’s target—will lead consumers, investors, and price-setting businesses to revise up their expectations for future inflation. Latest data reinforce Waller’s current view that the labor market is stable and inflation is too high. For at least the near term, policy will be focused on the inflation side of the Fed’s mandate. Waller thinks it’s a bad idea to abolish forward guidance altogether because of the potential volatility it creates. He also doesn’t support a very strong form of guidance over a longer period of time given future uncertainty. He prefers some form of fluid in-between signaling where policymakers indicate for example that the policy rate will, ceteris paribus, be increased by a specific cumulative amount within a given time period (eg +75 bps over 6 months horizon). It still preserves some flexibility for the central bank to decide on the increment and pace of rate hikes based on incoming data. Translating it to the current situation, Waller believes that hikes do not need to come at consecutive meetings, but they should be in place in an acceptable period of time. Bank of England governor Bailey talked about financial resilience in an age of repeated shocks. He also pulled the role of monetary policy into the debate. In theory, central banks cannot react mechanically to every inflation caused by supply shocks. However, the real danger comes when households and firms begin embedding higher inflation into wage demands and price-setting behavior because of successive (supply) shocks. Especially when people have recently experienced high inflation. The central bank’s tolerance of “looking through” may then become lower than before. In a supply-shock environment, policymakers may therefore even need to keep rates restrictive as growth weakens. Keeping inflation expectations anchored and preserving policy credibility is a clear nod towards the central bank’s changing vigilant stance which can soon morph into effective policy action (Nov rate hike 90% discounted).

News & Views

• Germany’s Economy Ministry more than doubled its growth forecast for this year, from 0.5% to 1.3% and more than the 1% expected in the pre-Iran war period. The boost comes after a stronger-than-expected first half of the year so far, driven by exports and a surge in government spending. The former benefited from a buildup in inventories elsewhere while the government embarked on deficit spending on infrastructure and defense. Growth for 2027 was revised higher to 1.1% from 0.9%. The Ministry warned that future economic developments remain heavily dependent on the course of geopolitical conflicts both in the Middle East and in Ukraine. Casting a shadow on the growth upgrade, are expectations for continued subdued private consumption, which suffers from rising prices. Private investment meanwhile is expected to recover only gradually.
• The Belgian ECB governor Pierre Wunsch in a comment to Reuters pushed back in the ongoing discussion at the central bank to increase the minimum required reserve ratio. This MRR ratio determines how much reserves commercial banks must deposit with their national central banks. These are non-remunerated reserves. The amount deposited on top of the minimum is remunerated at a rate equal to the deposit rate. This so-called excess liquidity is ECB legacy, created by the enormous bond buying programmes over the past decade. With rates now higher than in that (sub-)zero era, central banks incur steep financial losses and have stopped paying governments dividends as a result. Wunsch said that if the goal of raising the MRR ratio is to limit our losses, the tool “would become a quasi-fiscal instrument” of which the central bank needs to steer clear. Doing so anyway may also hurt commercial banks’ appetite in participating in future central bank operations, Wunsch added.