Central banks reiterated their commitment to achieve 2% inflation, albeit (i) the lack of new action and (ii) higher COVID-19 infection rates send risk assets lower
The Bank of England (BoE), on September 16th, as expected, kept its Bank Rate unchanged at +0.10% and its Asset Purchase Target at £745 bn (£684 bn as of meeting’s date).
What was not expected was the announcement that the MPC had been briefed to explore how a negative Bank Rate could be implemented effectively, opening the door for sub-zero UK policy rates in the footsteps of the ECB and the Bank of Japan. Note that the Bank of England and the Prudential Regulation Authority (PRA) will begin a structured engagement on the operational considerations in Q4:20. Following the announcement, the Sterling fell significantly intra-day (see Markets), while GBP OIS futures contracts, maturing in February 2021, are now pricing in policy rates falling below zero.
The MPC’s forecasts for GDP were revised up slightly, compared with August, pointing to the fact that the outlook for the economy remains unusually uncertain, under assumptions that Covid-19’s impact on the economy should steadily dissipate and that a “UK-EU” trade deal will be reached. BoE staff expects GDP for Q3:20 to be 7% below its Q4:19 level and CPI inflation to remain below 1% until early 2021 before settling at around 2% in two-years time. Official figures have shown that the economy grew by 6.6% in July (+18.5% since April’s trough but -11.5% since Q4:19) and that 12-month CPI inflation fell to 0.2% in August from 1% in July. The BoE dismissed recent stronger-than-the-Committee-expected economic data as “given the risks, it is unclear how informative they are about how the economy will perform further out”.
The Federal Reserve (Fed) maintained the Federal Funds Rate (FFR) in the 0% - 0.25% range at its meeting on September 16th, its first since the revision of its Statement on Longer-Run Goals and Monetary Policy Strategy.
As expected, the Fed also released new forward guidance on interest rates, described by Chair Powell as “very strong and powerful”. Based on the updated guidance, the Committee is expected to maintain the current range until maximum employment assessments have been reached and inflation has risen to 2% and is on track to exceed 2% for some time. Given the new guidance and the updated inflation forecasts, where inflation is seen rising to 2% in 2023, but not exceeding it, interest rates are not expected by the median FOMC official to increase from near zero at least until 2023.
Forecasts for real GDP compared with three months ago were revised upwards for 2020 and, given the higher base of comparison, lower for 2021 and 2022. Indeed, real GDP growth is projected at -3.7% yoy in Q4:2020 (-6.5% yoy in June projection), +4% yoy in Q4:2021 (+5%), +3% yoy in Q4:2022 (+3.5%) and +2.5% yoy in Q4:2023. Inflation is expected to fall below 2% until 2022 (1.2% in Q4:2020, 1.7% Q4:2021 and 1.8% in Q4:2022), before returning to 2% in Q4:2023.
Regarding QE, there was no significant change, stating that purchases would continue at least at the current pace over the coming months to sustain smooth market functioning and help foster accommodative financial conditions. Chair Powell stated that for now, “we think that our policy setting is appropriate to support the expansion” and passed the ball to the Congress as he thinks “that more fiscal support is likely to be needed”.
Global equity markets continued on a downward trend with the S&P500 declining for a third consecutive week (-0.6% wow ⅼ -5.2% MtD ⅼ 2.7% YtD). Losses accelerated on Monday, with euro area equities plunging by -3.6% and US equities down by -1.2%. Key drivers behind the decline were (i) pandemic related news with a significant rise in daily cases, especially in Europe, and the prospect of renewed lockdowns, (ii) a possible anti-trust lawsuit (FB) and signs that the Oracle-TikTok deal was failing, (iii) money laundering reports for major banks (-3.3% on Monday in the US, -6.3% in Europe) and (iv) declining prospects for a fifth coronavirus stimulus in the US, after the passing of Ruth Bader Ginsburg (RBG), who was Associate Justice of the Supreme Court, and the debate if the nomination for her replacement should be announced before or after the November 3rd elections.