The wait and see approach from G7 Central Banks

In the previous week, we had 3 major economies Central Banks Monetary conference meeting: Canada, Japan and EU. These 3 economies are heavily dependent on the price of Oil & Gas and geopolitical developments. While they are monitoring similar data, Japan´s monetary authority goals differ from Canada and ECB.

In this article:

1.       Canada

2.       Japan

3.       Euro Area

An insightful week to start the year

Canada  

GDP - expecting a technical recession in Canada. GDP in Q3 decreased 0.3% and now the forecast is for a decline of 0.2% in Q4 of 2023. Growth will continue to be flat in the near future due to the combination of higher prices and higher policy rates.

Inflation – for the past 4 months, inflation has been growing at a very slow pace (for 2 consecutive months) and also decreased twice already. The fastest growing components of CPI has decreased substantially and it is expected to continue to normalise. Should it continue with its slow pace increase and declines, it shall provide policy makers more confidence to start cutting the interest rate.  

Price of Oil – the price of oil has been steadily declining over the past 4 months, it has decreased from $95 per barrel to $74 per barrel;

BOC – emphasized that inflationary risk still persists in the economy and that core inflation is expected to reach the targeted level by 2025.

However, the Governor mentioned that demand is no longer above/higher than supply in the economy and coupled with a restrictive monetary system, it is now evident that there is enough pressure for inflation to resume to its normal levels. The governing council is comfortable with the current level of policy rate and have now shifted the topic of conversation from “how

much does policy rate has to increase to create sufficient restrictive level to bring down inflation” to “How long does it have to stay on the current level”.

Housing market prices are still very high and it does not contribute to a decrease in overall decrease in inflation. Measures of underlined inflation shows that pressure still persists to inflation increase, thus, the governing council shall keep monitoring the risks to inflation.  

The governor also mentioned that they do not intend to tight nor loose the monetary system too much, as doing so lead to other risks. And that monetary policy is working and they shall keep letting it work.  

Inflation expected to continue its decrease and reach the levels below 3% in the 2nd half of the year.

There was a clear consensus to keep rates at the current level. This does not signify that the governing council shall not increase rates, because should events that lead inflation to pick up pace arises, then the governing council will have to consider and might increase rates.

BOC is therefore letting the high rates do the work to see some inflationary pressures ease before initiating talks of cutting rates.

Japan

Inflation – inflation is indeed decreasing as forecasted by BOJ. The situation of Houthis poses a risk to higher prices of Oil which creates a risk for higher inflation.

Another risk to inflation is the USDJPY exchange rate which is currently at 147-148 level. USD is currently gaining more traction due to strong economic data which are forcing markets to price out The FED policy rate cuts out of the market, which in turn makes the JPY cheaper.  

In April, Japan will still be going through the wage-negotiating Shunto season, which makes April´s CPI paramount to gauge the overall trend and if it continues to follow the BOJ path.

BOJ – left its key monetary tools unchanged - as expected - while keeping a dovish stance with statements of “easing the monetary system if required” to the market´s disappointment.  

Meanwhile, the BOJ Governor Ueda´s remarks regarding inflation, solid wage growth and growing consumer consumption are leading markets to think that a tightening of monetary system may occur this year. One of the key indicators as to know when the right timing to exit from negative territory on policy rates is in the inflation figures.  

Currency – we expect the JPY to gain strength across the G10 countries as their Central Bank is the only one expected to increase policy rate this year and

the next while other G10 are expected to maintaining and cut theirs. Normally, the Japanese Yen is a funding currency used worldwide, but given that markets are expecting policy normalization from BOJ, they shall most likely turn to the Swiss Franc as the SNB wishes to have a weaker currency to aid in economic affairs – there loosing monetary system.

Euro Area

GDP – Contracted in Q3 of 2023 by 0.1%. The contraction was led by Netherlands, while Spain led the expansion by 0.3%. The forecast for Q4 2023 is for another contraction of 0.1% - thus putting EU in a technical recession. 

Inflation – Inflation outlook has been confirmed and it has been following their projected path and underlined inflationary pressures are decreasing, apart from housing prices which its resilience is stronger than expected.

ECB – in its most recent Monetary Conference, the ECB kept unchanged its monetary tools. Underlined inflation is declining due to sufficiently tight monetary system. The Governing council is adopting a data depended approach to decide whether to cut policy rate or not, mainly focusing in CPI data. It is expected for the economy to grow in the near term.  

However, the risk to growth is tilted to the downside with risk of a technical recession if monetary system becomes too restrictive.  

Risks to higher inflation are as follow: wage increase more than expected, profit margins more resilient than expected, geopolitical issue which can affect oil & gas prices.  

In the conference, when asked if rates cuts can be expected in summer, President Lagard said the following: it is premature to discuss rates cuts. We have to continue to be “data” dependant instead of being “date” dependant. Her tone is very confident, she is more hawkish than BOC governor, but the stance is practically the same – data dependant.  

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