Policy Cross-Currents Set To Strengthen

• ECB easing alongside US employment report gives scope for big currency moves
• Macroprudential policy action could buy the BoE time before raising rates
• Global activity trends a focus alongside geopolitical risks

Global policy divergence comes into sharp relief. With December’s FOMC meeting still expected to herald the first US tightening of policy in close to a decade (Chart 1), Friday’s US employment report provides the last meaningful opportunity for the data to change the facts on the ground. A firm outturn for November payroll growth and the labour market more broadly is expected. But with FOMC officials having in recent comments lowered the bar for ‘acceptable’ outturns to a range only modestly above 100k per month, a December lift-off seems unlikely to be delayed. Indeed, hardening expectations following a solid report should see a further dollar appreciation, sending the Euro below the recent 1.06 or so. Yet, Thursday’s ECB policy decision is likely to be even more important as it seeks to address a disappointing outlook for Eurozone inflation. if the ECB is able to meet ever-increasing market clamour for a big policy loosening, a move towards parity could loom.

Expectations mount for Draghi’s big stimulus package. With ECB President Draghi only last week noting that “we will do what we must to raise inflation”, expectations are widespread for a multi-faceted easing. This is likely to include a 20bp deposit rate cut, and both a larger and longer asset purchase programme (Chart 2). Some uncertainty remains about what other measures the ECB could adopt that could yet be clarified by judiciously-timed leaks. A two-tier approach to a reduction in the deposit rate is apparently being considered for larger balances. The ECB might also make changes to the main refinancing rate. Overall, the market consensus is mostly around the view that Draghi will not want to disappoint. Yet, any desire to keep some policy powder dry means that the checklist of announced measures could underwhelm, even if compensated by hints of future action. Meanwhile, Eurozone-wide inflation data (Wed) will provide an update in advance of the policy decision and updated ECB economic projections.

BoE likely to opt for tighter macroprudential policy measures. Expected ECB easing and Fed tightening are likely to leave sterling buffeted by cross-currents. UK data this week are unlikely to provide much of a policy steer, with PMIs (Tue, Wed, Thu) expected to reinforce an impression of a moderate pace of activity. Tuesday’s publication of the BoE’s Financial Stability Report could be of more interest, potentially heralding new macroprudential policy actions. Last week’s appearance by BoE Governor Carney at the Treasury Select Committe dropped hints about an increase in banks’ counter-cyclical capital buffer. Separate action could also be announced to cool buy-to-let lending, adding to tax measures from the Autumn Statement.

Global activity trends still bear watching. This week’s central bank policy actions also include decisions by the RBA and BoC, though no change is expected from either. FOMC speakers, including two sets of remarks from Chair Yellen in advance of Friday’s employment report, seem more likely to focus on the path of policy beyond a first move, with the emphasis on gradualism consistent with expectations of a ‘dovish hike’. But global PMIs - including readings for China (Tue) and the US (Tue, Thu) - still hold potential for a renewal of anxiety about the pace of global activity growth. In this light, any abrupt weakening - a possible impetus for a renewal of financial market volatility - would be the most likely reason to stay the Fed’s hand in December.

Oil market and geopolitical risks in focus. Against a backdrop of subued oil prices and weakness in global headline inflation rates, Friday’s OPEC meeting holds some risk of a reversal of the cartel’s current stance of continued high output. Any hint of cooperation with non-member producers, or better output discipline, could challenge the bearish consensus at recent low prices. Likewise, any serious flaring of geopolitical tensions could add to the risk premium built into prices.

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