With the risks of sustained deflation becoming more real and the ongoing talk about QE, there is no reason to delay this move, says Simon Smith of FxPro, even though the effectiveness isn’t that clear.
In the interview below, Smith also explains why the cycle of rate hikes could commence in the UK already in November, and also talks about other topics moving markets.
Simon has over seventeen years experience of macro forecasting and investment strategy research. Prior to joining FxPro in May 2010, Simon was a consultant with Thomson Reuters, having spent four years as Chief Economist at Weavering Capital. He has held economic and strategy positions with Standard & Poor’s, together with consultancy firms 4Cast and MMS International. Simon holds an MSc. in Economics from the University of London and a BSc. from Brunel University.
- Does Draghi’s speech in Jackson Hole mean that QE is imminent in the euro-zone?
Yes, even though I would question its effectiveness and also exactly what it means. There is no denying the risks of sustained deflation, beyond what we are already seeing in the periphery and also the impact that it is having on longer-term inflation expectations. The ECB had been talking about asset-backed purchases for nearly 6 months now and there is no reason to delay. I don’t see the ECB buying government bonds outright, given the institutional and political constraints, but anyway, yields are already at record lows, so I question what impact it would have anyway. Even though the impact of any measures announced in September is going to be limited, in absolute terms and in relation to the early QE programs seen in the UK and US, the ECB will be hoping that there is an impact on the currency, especially as the dollar looks to be more assured.
- We are nearing the third anniversary of the SNB’s floor of 1.20 under EUR/CHF. The cross has been digging lower lately. Is there a chance that the markets will test the SNB’s determination and try to break the floor?
It’s difficult to see the scenario of a further move towards 1.20 being avoided given the downward pressure on the euro that is likely to prevail over the coming weeks. The SNB has been pretty vocal and determined in relation to the band and there are options on the table in terms of defending it and the market has been hurt previously in betting against this, so I am not so sure the market will be as determined this time. The SNB has had a long time to think for this, so measures such as negative rates on short-term deposits are likely to be seen first.
- Finally, two MPC members voted for a rate hike in the UK and this came after Carney said the BOE doesn’t need to wait for an actual wage rise in order to act. Can we expect a hike as soon as November, or will the lack of wage inflation keep the majority of the MPC unchanged for longer?
I am still thinking we are more likely to get a move this year and November remains favoured. I thought the arguments were interesting, with both members focusing on the tactical aspects of when to start the rate hike cycle, so moving earlier makes it more likely that BoE can deliver on their plan of slow and steady rate increases to a lower neutral rate (to paraphrase). Wage inflation can be a lagging indicator, so I think it would be unwise to become too focused on this in relation to the timing of the first hike.
- The Fed convenes in September for what is expected to be the last taper before QE completely ends in October. Is the time ripe for Yellen and co. to lay out a more detailed exit strategy and perhaps provide a hint for the timing of a rate hike?
I think we are not quite there yet. In terms of timing, Yellen made the mistake back in March of trying to be too specific and this did not work in her favour. I would suggest that the next move will be to soften the forward guidance in the statement to bring some more uncertainty into the timing as I don’t believe it is wise for central banks to try and lead markets too much as to when rates may increase. Forward guidance worked at the early part and in the depths of the crisis. I think it’s had its day and central banks getting too involved in guiding markets probably does more harm than good at this point.
- BOJ governor Kuroda said they are halfway to beating deflation. Does this imply continuing the current policy unchanged or is more stimulus on the cards?
As yet, I don’t see more stimulus coming from the BoJ. Whilst the yen has been trapped in a tight range vs. the USD, I am sure the BoJ is hoping that dollar strength does some of the work for them. But this is only going to have a limited impact on the economy, as was the case with the recent bout of yen weakness which for various reasons did not boost growth (increase in energy imports, more goods being manufactured overseas). So whilst a weaker yen may help, it is not necessarily going to take them along the remaining road towards beating deflation.
A previous interview with Smith: Fed cannot stop the stock market; ECB would feel relaxed with EUR/USD at 1.20
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