Weekly Update - Game Over? Not yet...

In late April, the Bank of Canada (BoC) was the first to move when it announced the tapering of its asset purchases from C$4bn per week to C$3bn. It justified this move by pointing to a dramatic upgrade in its forecasts – in January it had expected first quarter (Q1) GDP to fall by -0.6% quarter-on-quarter (QoQ) whereas growth is now forecast at 1.6%, thanks to vigorous fiscal support in the face of the latest wave of infections. This takes 2021 growth estimates to 6.5% from only 4% in January and the BoC now expects that by H2 2022, all economic slack will have been absorbed and inflation will be sustainably around its 2% target.

At its meeting in early May, the Bank of England (BoE) made no changes to policy settings, keeping its policy rate at 0.1% and holding the total size of its asset purchase programme steady at £895bn. Like the BoC, the BoE revised its 2021 growth forecasts higher, to +7.25% versus its previous +5% estimate. This means that GDP will be back to pre-crisis levels by Q4 this year, a quarter earlier than previously thought, thanks to faster consumption of pent-up demand. And, like the BoC, the BoE announced it would reduce the weekly pace of its asset purchases, from £4.44bn to £3.44bn. In his statement to the markets, BoE governor Bailey went out of his way to emphasise that this was a mechanical change rather than a signal that policy is being tightened. The BoE had fixed a £190bn envelope for asset purchases this year, implying as £3.7bn weekly rate – by reducing the weekly pace, Bailey is simply spreading the remaining purchases out evenly over the rest of the year. This explanation is borne out by the bank’s longer-term forecasts for GDP growth – 2022 has been cut from 7.25% to 5.75% and 2023 left unchanged at a modest 1.25%.

The European Central Bank (ECB) and the Federal Reserve (Fed) show no sign of following suit however. The ECB announced that it would accelerate the pace of asset purchases in Q2 given the perceived tightening in monetary conditions and, indeed, the weekly pace of its Pandemic Emergency Purchase Programme buying has accelerated by 33% since Easter reaching €25.3bn. The US Fed has stuck to its monthly target of $120bn in purchases despite the recent string of stronger confidence data – for example, the March Institute of Supply Management survey of manufacturers hit a 37-year high, before easing back in April. Recent statements from Fed decision-makers have been consistent. Although the economic outlook has brightened, there is still a long way to go before the Fed tightens – one fifth of the workforce in the lower income categories is still unemployed and the Fed remains convinced that this year’s spike in inflation will prove transitory. These views were given some weight by the April payroll data – observers were disappointed to see only 266,000 new jobs added and the unemployment rate edging up to 6.1%.

Bottom line. We continue to expect a solid cyclical recovery in activity in the second half, in particular in Europe. However, we do not expect a lasting pick-up in inflation – output gaps remain very wide, the global labour market still has enormous slack and structural disinflationary forces (such as aging demographics and innovative technologies) have not disappeared. In this context, central banks are likely to keep policy very accommodative, which should continue to support risk appetite

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