Following the lead of the US Federal Reserve, and Bank of Canada before that, financial markets are increasingly adopting the view that other major central banks are about to start lifting interest rates.
Nothing demonstrates this shift in market sentiment over the past year than the chart below from the Institute of International Finance (IIF).
Going back to the day before the US presidential election held last year, it looks at the amount of tightening priced in by financial markets for various central banks in 2018, taking snapshots as at the end of 2016, September 19 and September 22 following the most recent US FOMC meeting.
There’s been quite a shift, particularly since the end of last year, with markets pricing in monetary tightening in the UK, Europe, Australia and New Zealand, among others.
The only major central bank excluded from this list is the Bank of Japan.
Following years of policy easing, markets now think that we’re in for a period of policy tightening, suggesting, at least on the surface, that the current upswing in the global economy will continue in the year ahead.
In terms of the G3 central banks — the Fed, ECB and Bank of Japan — the IIF thinks that markets are moving in the right directions when it comes to the outlook for policy settings.
Where the Fed is concerned, we continue to forecast a hike in December, in addition to two hikes in 2018. This is one less than the Fed expects per last week’s Statement of Economic Projections. We have dropped one hike from next year given the uncertainty that Fed succession casts over the institution’s reaction function, though our three hikes remain above the forwards, which are pricing just shy of two hikes through end-2018.
The ECB and BoJ both forecast that core inflation will climb to 1.1% in 2017. In the case of the ECB, we believe there is downside risk to this forecast, given how much sequential inflation would need to pick up. In the case of the BoJ, this forecast would require a very large pick-up in underlying inflation, which is unlikely to happen. That said, the political reality of the Euro zone is such that QE tapering is likely to be announced later this year and we forecast a hike in the deposit rate for December 2018. For the BoJ, no such constraints apply and, in fact, we believe that last week’s dovish dissent over the inflation outlook signals a central bank firmly on hold. We forecast unchanged yield curve control curve targets.