The past week has been a very drifty week in financial markets, with little in terms of first tier economic data. Instead, markets have continued trying to digest current, dominant macro questions/uncertainties: relative monetary reaction function against a differentiated global recovery, relative recovery pace vs. sustainable recovery pace and inflation transiency (the emphasis being where our core views differ from consensus). Indeed, from our perspective, there has been a reinforcement of the differentiation theme and a number of policy divergences have become clearer. We have some thoughts.

Firstly, and perhaps most interestingly, this week has seen a tempering of the markets’ hawkish European Central Bank (ECB) expectations. Last week, we stated our clear opinion that the consensus market view - that the upward revisions to the staff projections of the ECB at the June 2021 meeting will be sufficient to warrant a reduction in the pace of asset purchases under the ECB’s current PEPP programme – was likely misplaced. Firstly, we argued that a reduction in the pace of accumulation of a fixed ‘envelope’ of quantitative easing did not amount to a tapering. Further, we argued that such expectations were out of context, given the persistent inflation and labour market weakness and the fact that financial conditions have already tightened significantly (through both bond yields and currency appreciation), as downside (virus-related) risks had receded.

This week, commentary from various central bank officials has pushed back against this consensus, arguing that “the ECB will be at least as patient as the Federal Reserve (Fed)”, that “we are seeing an undesirable increase in yields” and that only “sustained inflation”, of which there is no sign, would warrant a slowing of the PEPP purchases. Central expectations for the monetary reaction function are now more aligned with our thoughts – however, there are still two weeks to go!

The debate over differentiated policy response has also broadened. As the global growth backdrop and vaccine rollout success have, to varying degrees, removed downside risks - and thus obstacles to monetary normalisation:

• The RBNZ pulled forward their Overnight Cash Rate (OCR) projection profile such that it now includes a 25bp hike in the second half of next year and 150bps cumulatively by the first half of 2024 – due to a booming housing market, higher inflation profile and a tighter labour market.
• The CE3 countries (Hungary, Poland and Czech Republic) have also been notably more hawkish of late, against a backdrop of an improving euro area and regional growth and upside inflation surprises – not to mention improved Covid vaccination rates.
• While market expectations of rate hikes in South Korea are arguably already significant over coming years, the Bank of Korea meeting this week likely marked a hawkish policy pivot, with the Governor signalling greater emphasis on the “build-up of financial imbalances”, alongside higher growth and inflation forecasts.
• Indeed, even the UK appears to be in the process of adopting a more hawkish monetary reaction function, with one external MPC member suggesting that a rate hike from the MPC in 2022 is possible, contingent on a smooth transition of the labour market from the furlough scheme.
• In China there are some tentative signs that the monetary stance may also be erring towards further tightening, with a contraction in Total Social Financing (TSF) – a tightening of the credit impulse – and fiscal tightening of perhaps 1.5% GDP.