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Policy Divergence Back In Fashion

The ECB met last week; the Bank of England and the Swiss National Bank met today; the Federal Reserve and the Bank of Japan meet next week. Central bankers just can’t stay out of the limelight and the message is that (limited) monetary policy divergence is making a come-back.


Will The Fed Raise? Its chair, Janet Yellen, has left the markets in no doubt – the case for a rate increase has strengthened. However, the committee is divided. Just this week, an influential governor, Lael Brainard, set out four reasons not to move soon – low inflation, labour market slack, a muted recovery in wage growth and weak demand from abroad. The judgment is fine – moderate growth and price inflation on the one hand versus a low jobless rate and gradually rising wage inflation on the other. Our view, a commonly-held one, is that the FOMC will remain on hold in September but raise rates by 25 basis points in December.

Will The Bank of Japan Ease? There is a strong case for further Bank of Japan easing – inflation is currently minus 0.4% versus a target of 2% – but the question is how. The BoJ embarked on an aggressive programme of asset purchases in April 2013 and resorted to negative interest rates in January this year. Neither has been a great success, partly because the government has not fired the other two arrows of Abenomics with any conviction. At next week’s meeting, BoJ boss Haruhiko Kuroda may present the results of a “comprehensive assessment” of past policies. We expect some easing measures but are unsure in what form.

And the ECB? Stuck in neutral for now. Ever since his “whatever it takes” pledge in 2012, Mario Draghi’s ECB has been on a mission to ease. However, despite the shock of Brexit, the eurozone central bank was relaxed about the economic outlook and its policy stance at the past two meetings. The ECB staff forecast barely changed last week and Mr Draghi was in no hurry to act.

What Do The Markets Think? Central banks drive markets and so market expectations of future policy moves do matter but the markets do not appear to expect much. Monetary policy is not much about interest rates these days but, for what it is worth, three month money market futures imply an increase of about 10 bps in US rates, no change in euro rates and a 10 bps decline in Japanese rates over the next six months.


Two year government yields may be more useful in that they are sensitive to both interest rates and asset purchases. Since end-June, US yields have picked up by 17 bps, pretty much endorsing one rate increase, but JGB and bund yields have barely moved.

The conclusion is that the Fed is set to hike and the BoJ to ease but none of the G3 central banks look like taking drastic action.

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