Aurelia Butler

(Reuters) – With inflation surging, the Bank of Canada is likely to change its interest rate guidance in the new year so that it has the option to raise borrowing costs earlier than planned despite the threat the Omicron variant poses to growth, analysts said.Last week when it left the key overnight rate at 0.25% – where it has been since March 2020 – the bank reiterated its guidance, saying it would not raise rates until economic slack has been absorbed “in the middle quarters of 2022″.But it has turned hawkish since then, warning that inflation will run hot for longer than expected, and Governor Tiff Macklem said the slack in Canada’s economy caused by the coronavirus pandemic has substantially diminished.”Even if the Bank of Canada wants to be a little bit cautious in front of a potential winter set of shutdowns…, if they think inflation expectations are starting to become unanchored, that will be their primary concern,” Andrew Kelvin, chief Canada strategist at TD Securities.”Certainly in January they will want to give themselves the option of March,” he added.The bank will next meet to decide rates on Jan. 26, when it will also update its forecasts. Money markets expect about four rate hikes next year, with the first one coming in March. They see about a 40% chance of a January move.”January will be a declaration that every meeting is now a live meeting” for a rate increase, said Adam Button, chief currency analyst at ForexLive. While the spread of Omicron could undermine growth, it could also reduce slack in the economy more quickly by dialing back the speed at which the economy can grow, analysts said. “I don’t think (the bank) will change course on Omicron because they’ll see that as inflationary” because it could disrupt supply chains even further, Button said.November inflation hit nearly 5% and is starting to pinch. On Wednesday, Macklem said the bank is getting closer to no longer providing forward guidance that guaranteed low interest rates during the pandemic, which was seen as a signal by some analysts that it would be dropped in January.A shift in guidance in January would probably mean the Bank of Canada would start raising rates ahead of the U.S. Federal Reserve, which on Wednesday said it would speed up a phase-out of its bond-buying stimulus ahead of possibly three interest rate rises in 2022. Lift-off by the Fed is expected by money markets in June.The Bank of England on Thursday became the world’s first major central bank to raise borrowing costs since the coronavirus pandemic hammered the global economy.A bevy of Canadian economic data, including December jobs and inflation, will set the tone for January meeting. While most economists are skeptical about an increase as early as January, it is not impossible, said Doug Porter, chief economist at BMO Capital Markets. “Never say never. I definitely can’t rule it out,” Porter said. “We’ll have lots of data by then,” he said, adding that the figures would have to all point in “one direction” and create a sense of urgency for the bank to move so quickly. More

Speaking a day after the European Central Bank raised its inflation projections across the board, Villeroy said that inflation had probably peaked and would now converge towards the ECB’s 2% target in 2023 and 2024.The ECB said on Thursday it now sees inflation averaging 3.2% next year, before a drop to 1.8% in both 2023 and 2024.”After the hump, we’re not coming back to the pre-COVID regime of very low inflation,” Villeroy told French radio station BFM Business.”There is a new inflation regime around the 2% objective. In some ways, it looks more like what we had before the financial crisis,” he added.Villeroy said that that inflation backdrop required a “pragmatic steering” of monetary policy depending on the real economic conditions.Leaving policymakers plenty of flexibility in the face of risks from new COVID variants and supply-chain pressures, the ECB said on Thursday it will end emergency bond buys next March but temporarily double the pace of its longer-running Asset Purchase Programme (APP) to ease the transition.Villeroy said that amounted to a significant reduction in asset purchases, which had been overlooked by some market analysts as average monthly purchases would go from 90 billion euros this year to 20 billion by October next year.”That’s an extremely sensitive reduction in the pace of purchases,” he said. More

Twenty-four hours on and we’re still trying to work out why the Bank of England hiked rates. A meagre 15 basis point rise to 0.25 per cent will be too small to have any impact on the economy. It hardly compensates for the fall in real rates that’s resulted from the recent dramatic rise in inflation. Though for owners and workers in the UK’s services sector, fearing for their livelihoods in the face of the latest spike of Covid cases, it might feel like a kick in the teeth.The decision is driven instead by a desire to anchor inflation expectations around the Monetary Policy Committee’s target of 2 per cent — some feat given that inflation is currently running at 5.1 per cent. While this hike is small, the idea is that by signalling the direction of travel (and a willingness to use interest rates as a policy tool), people will anticipate further hikes in the new year. Yet to pull off this Jedi mind trick requires credibility.A lack of coherence between what the MPC has said of late and what it has done — both at its November and December votes — has left markets with no clear sense of how to read policymakers’ pronouncements. The Old Lady has proven herself an unreliable boyfriend, yet again. Couple that with the climate we have right now, rife with uncertainty, and we’re not confident markets will take hints about a steady crawl up the curve that seriously. At least not on the back of a cut as small as this.The more fundamental issue, however, is that the UK is grappling with inflation of the sort that its central bankers can do little about. The bulk of the lift in prices has come from the rise in energy costs. Another source is the disorder in global supply chains. Both are factors that Putin and spike proteins have greater say over than the Bank. We remain unconvinced that the recent surge is impacting the labour market. The UK is not the US.Nor will the problem of supply-side driven inflation die down. China has already identified cases of Omicron, with factory shutdowns likely to follow. Even when the pandemic becomes endemic, we’re faced with the twin threats of more frequent extreme weather events and ageing populations. Climate change threatens to have an impact on harvests of crops such as cotton. The past year has given us some insight into how labour shortages can be expected to affect production. It is reasonable to expect that the structural forces that kept a lid on prices over recent decades, such as the impact of Chinese labour and production on globalisation, to diminish too. More volatility in output and prices is the likely result. Monetary policy is not entirely useless in managing whipsawing inflation. But its masters ought to be more honest about the degree to which they can now be expected to deliver stability and prosperity through this channel alone. Money’s price is the only thing central bankers can truly influence. Don’t get us wrong — money clearly matters for inflation. But in a time of global outbreaks and climate change, shocks on the supply side may matter just as much. If not more. Yet to admit this weakens policymakers’ hand. Acknowledging that influence over money — substantial though it is — may not be able to tame bouts of inflation would force them to concede that inflation may owe more to price pressures themselves than the credibility of those tasked with keeping them in check. Economist Jeremy Rudd made a strong case here for the view that it is inflation itself, not targets set by policymakers — and their influence on what people think will happen in the future — that really matter. BoE governor Andrew Bailey, and others in the central banking priesthood, have been dismissive of Rudd’s view. Instead, they choose to stick to the textbook and claim small hikes change behaviour by shifting inflation expectations and rendering any spike in prices temporary. Which makes sense, given that the entire intellectual framework upon which central banking has been based for the past 30 years would collapse if Rudd was proved correct. The foundations are already shaky. A global financial crisis, followed by a decade characterised by weak official inflation figures combined with surges in asset prices, has already led many to suspect that something is amiss with a system that claimed central bankers could be entrusted with delivering steady growth. If people and businesses no longer think they can control inflation, then we suspect the era of the omnipotent, independent monetary guardian is done. So we have our answer. Thursday’s rate hike was about Threadneedle Street convincing their critics that central banks still have the power to manage the economy. Perhaps time will prove the MPC right and we’ll look back on the hike yesterday as the first of a series of masterstrokes that reined in price pressures. We fear they’re wrong, however. They might get lucky and benefit from a fall in inflation during the second half of next year, for which they can claim credit. That’s likelier, in our view. Eventually though, we suspect they’re going to get found out. More