The last month has seen G7 central banks re-emerge as the dominant driver of financial market volatility with policy makers becoming increasingly uncomfortable with the direction of travel, at least in most cases.
All of a sudden the Federal Reserve appears to be questioning the need to raise interest rates so quickly, the Bank of England is considering tightening as it’s more worried about inflation than the economy and the Bank of Canada has already raised interest rates despite falling well short of its inflation target.
Two central banks that have so far continued to operate with some predictability are the ECB and the Bank of Japan, both of which are due to announce their latest monetary policy decisions on Thursday. Can we still rely on them not to have the sudden change of heart that their peers have had?
BoJ Refusing to Fall in Line With Other Central Banks
Given the shift that we’ve seen in recent weeks, it’s difficult to say with any degree of certainty but of all the above, I think the BoJ and ECB may be the two that will follow a more predictable path (famous last words).
The BoJ has shown no desire to deviate from its ultra-accommodative stance, in fact it recently increased its bond purchases because the yield on 10-year JGBs was ticking higher, driven by similar moves elsewhere. With the central bank vowing to keep the 10-year yield around 0%, the move was a signal to markets that it is not in the same camp as a number of its peers. With that in mind and considering inflation remains far from target, I don’t expect any sudden shifts on Thursday.
Source – Thomson Reuters Eikon
The ECB could be more interesting though, with the asset purchase program in its current form – €60 billion per month – due to expire at the end of the year. While the central bank will likely wait until September to announce how the program will be extended, it may use this month’s press conference – being the last before September – to lay the groundwork for such an announcement.
We may therefore get some insight into what the central bank is considering doing next. For example, will it lay out plans to phase out asset purchases over a certain period of time? Or will it simply announce another short extension while reducing the size of the program, as it did in December, while insisting it is not tapering? We may get some insight into this on Thursday.
Of course, there is always the possibility that it simply extends the program as it is, although this appears the least likely option, which it may allude to.
Will Dovish Draghi Throw a Spanner in the Works?
Whatever the central bank does, these events often stir up some volatility in the markets, particularly in the euro and eurozone bonds. And in the current environment, these may be particularly vulnerable to any unexpected suggestions, intentional or otherwise.
With the euro trading near the highs of the last two and a half years against the dollar, it’s potentially looking a little overstretched which could leave it vulnerable to a dovish surprise from ECB President Mario Draghi.
The flip side of this of this, of course, is that a more hawkish message could trigger a move through this major resistance which in turn could be very bullish for the pair. Clearly we’re in for a very interesting end to the year for markets and the ECB could well be at the centre of it all.