Unchanged monetary policy

Last week, the European Central Bank decided not to change its monetary policy. Noting that the economy is still recovering but under that the threat of the pandemic and the Delta variant remains, the ECB chose to hold interest rates steady and maintain its accommodative policy by leaving its asset purchases unchanged. The only novelty was the updated ‘Forward Guidance’, an exercise in communication whereby it gives the markets an indication of the future course of monetary policy. The ECB sought to convince investors that it will not withdraw its support too quickly and risk derailing the economic recovery. In concrete terms, before interest rates can be raised, inflation will have to reach ‘two per cent well ahead of the end of its projection horizon’ – covering two to three years –  ‘and durably for the rest of the projection horizon’. Moreover, it will take ‘underlying’ inflation (i.e. excluding food and energy prices) into account. The ECB will thus be able to justify sticking to its policy if it expects, as it does today, that inflation will only be temporary. The International Monetary Fund seems to be of the same mind. It expects inflation to return to pre-COVID levels in most countries in 2022, although it adds that uncertainty remains high. In June, inflation was 5.4% in the US and 2.5% in the UK. The IMF is still forecasting global growth of 6% in 2021, but the breakdown has changed: it now expects advanced economies to grow an additional 0.5 points and has cut projections for emerging economies by 0.4 points. The institution observes that disparities in access to vaccines between developed and emerging countries are effectively dividing the global recovery into two blocks: countries that can expect activity to normalise this year and countries that will continue to suffer the COVID pandemic.

On Friday, the Russian central bank raised its interest rate by 100 basis points as expected, to 6.5%, in order to counteract rising prices. This is the fourth consecutive hike and the biggest since 2014. Inflation in Russia is currently around 6.5% (annualised), well above the 4% target. Last week, the rouble initially lost ground as oil prices fell and geopolitical tensions increased. Amidst a still-strained diplomatic context, the Russian army has flaunted a successful hypersonic missile test and a new stealth fighter. On the other hand, the prospect of progress on the Nord Stream 2 project played in favour of the Russian currency. These factors and the expectations regarding the CBR’s decision have generated some exchange volatility, but in the end the rouble is still trading between 73.50 and 74.00 to the dollar.

Yesterday, Asian stock markets plunged for the second day in a row after Beijing tightened its regulatory leash once again. The Chinese stock exchanges of Shanghai and Shenzen lost 2.5% and 3.3%, while the Hong Kong stock exchange fell by 4.2%. After attacking cryptocurrencies and then going after e-commerce and the technology sector, the Chinese government has now turned its attention to food delivery platforms and private education firms. A great deal of uncertainty is causing investors to wonder which sector will be next to face Beijing’s regulatory crackdown. Investors are also having a hard time pricing in Chinese political and regulatory risk. The Chinese yuan also depreciated sharply and hit a three-month low (just under CNH 6.53 to the dollar).

The pound sterling has recovered this week from a low of 1.3572 last Tuesday. It is now trading close to 1.39, and one euro is worth just over 0.85 pounds. The currency was buoyed by a drop in new COVID cases in the UK for the fifth consecutive day. However, caution is advised as these figures do not yet reflect the effect the lifting of restrictions on 19 July. Yesterday, the British pound continued to appreciate, which was also helped by the weakness of the dollar. The greenback suffered from a decline in US Treasury yields and poor economic figures (weaker-than-expected durable goods orders). In terms of government bond rates, the 10-year Treasury note went from 1.30% to 1.23% in a few hours, reflecting the nervousness of the markets ahead of the Fed meeting. The Fed is meeting right now. And, like its European counterpart, it should keep its monetary policy unchanged. At its meeting last month, the Fed surprised the markets by showing through its dot plots that rate hikes could come sooner than expected. Since then, Jerome Powell has repeatedly reaffirmed that the US central bank will continue to support the economy. This time again, the language they use will be carefully scrutinised, as the slightest phrase, the slightest mention of the Delta variant or tapering will be interpreted and will influence the price of the greenback in one direction or another. Last but not least, Jerome Powell’s four-year term ends at the end of January. He was originally appointed by Donald Trump to replace Janet Yellen, who is now Secretary of the Treasury. The question of whether he will be replaced or reappointed will soon arise.