ECB: Challenges in normalising policy – SocGen


The ECB’s biggest challenge is the downward move in neutral policy rates, particularly in nominal terms, according to Kit Juckes, Research Analyst at Societe Generale.

Key Quotes

“The lower the eventual peak in the fed funds rate, the greater the challenge that poses for any other central bank that wants to normalise rates. If the fed funds rate peaks at a level barely above 2%, the ECB would be unable to keep the euro here unless it persuades markets to believe that its peak in rates will only be a little above zero. It is no wonder we’re hyper-sensitive to any mention of reflation by ECB President Mario Draghi.”

“And if that’s true of the ECB, it’s a similar problem for other central banks. There isn’t much room for the Bank of Canada, RBA, RBNZ (or, for that matter, the Bank of England) to raise rates without sending their currencies up, unless markets rethink the eventual peak in fed funds.” 

“Market pricing in the peak fed funds rate will only be dragged higher by inflation, in wages or prices, and/or the prospect of easier fiscal policy. Maybe the mood at the start of this week was extreme, with healthcare reform collapsing again, with inflation expectations falling further and with US economic data underwhelming. But while the FOMC may yet start to sound more hawkish again if equity indices scale new heights, we are going to need some clearer signs of an impending uptick in inflation to really change the mood. Friday’s PCE data aren’t likely to provide that.” 

“Until then, we’re getting some livelier moves in G5 FX, but the underlying carry and yield friendly environment is intact. What kind of emerging market tantrum can we get going if our greatest fear is a 2.5% terminal fed funds rate? Commodity prices, Chinese debt and Brazilian politics can all affect sentiment, but the underlying strength of EM is built on the idea of a low terminal fed funds rate.”


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