ETF Securities Research Blog

Central banks: hear no inflation, see no inflation, speak no inflation

While global inflationary expectations have moderated as a risk-on mindset has gained momentum following the French Presidential first round vote, actual inflation is surprising to the upside. While the Bank of Japan (BOJ) and European Central Bank (ECB) have met investor expectations for policy announcements in recent days, the US Federal Reserve (Fed) could disappoint at its June meeting.

Major central banks have recently maintained the status quo with expansive stimulus programs, reluctant to rein in stimulus programs. While such cautious behaviour will prevent another ‘taper tantrum’ it could see inflation meaningfully breach inflation targets. Inflationary expectations have moderated, but we feel rising inflationary momentum is being underestimated by some central banks.

inflation surprise

Understandably, the BOJ is no closer to tapering: the Japanese central bank softened its inflation outlook at this week’s meeting (from 1.5% to 1.4% by 2017/18), as wage growth remains muted, despite a relatively tight labour market.

Similarly, the ECB remains cautious in its approach, appearing to lack confidence in its expectation that inflation will return to its target. Although not explicitly stated, the political uncertainty in Europe must be a concern for the central bank as it delays the return of normal economic activity. The political uncertainty that is rife in Europe hinders a proactive reform agenda for government policy. The ECB’s simulative stance is positive for supporting growth but will likely need to be modified before year-end as inflationary pressure picks up, fuelled by growth momentum, as uncertainty fades. Undervalued European equity markets are likely to benefit, not be hampered, by a more hawkish ECB, as they respond to the potential from a stronger economic landscape. The Euro should also be supported by the ECB reducing its stimulus,

Meanwhile the Fed is likely to disappoint the market by keeping rates unchanged. The market is pricing in a 60% chance of a rate hike at its June meeting (from highs of 85% in recent weeks). We expect that June is too soon for the Fed to raise rates despite the upward momentum in core inflation. The USD will remain soft, encumbered by a central bank that remains behind the curve despite evidence of building growth and inflation pressures.