Caught off guard: Bank of England keeps interest rates unchanged, surprising markets

On the latest edition of Market Week in Review, Investment Strategist Alex Cousley and Investment Strategy Analyst BeiChen Lin discussed key takeaways from the recent spate of central bank meetings. They also spoke about the latest COVID-19 outbreak in China and developments pertaining to the country’s embattled property sector.

Fed announces tapering timeline

At the conclusion of its two-day policy meeting, the U.S. Federal Reserve (the Fed) announced that it will begin tapering its asset-purchasing program later in November, Cousley said, noting that the decision had been very well telegraphed by central bank officials over the past few months. Of greater interest to markets in the lead-up to the meeting, he said, was whether the Fed would change its stance on inflation, which the central bank has characterised as transitory ever since prices began marching steadily upward in the spring.

“The Fed’s November statement showed that the central bank is still in the transitory camp when it comes to inflation, but officials did acknowledge some uncertainty in their position by noting that inflation is expected to be transitory, rather than straight-up classifying it as transitory, like in previous statements,” Cousley explained.

Fed officials also weighed in on the nation’s labour market recovery, with Chair Jerome Powell noting in the ensuing press conference that there’s still more ground to cover before full employment is reached. Importantly, the Fed chair also stated that there’s been no discussion among officials about raising rates yet. “The central bank has made it clear that this whole process will be very sequential, with the first step being the wind-down of quantitative easing,” Cousley said, explaining that the Fed will only begin to think about rate hikes once tapering is complete. The tapering process will probably take about seven months, meaning it will be wrapped up sometime in mid-2022, he explained. “At that point, Fed officials will need to see signs that the U.S. economy has attained full employment before considering tightening monetary policy,” Cousley stated.

BoE holds off on rate hike, RBA ends yield-curve control

Turning to the UK, Cousley noted that the Bank of England (BoE)’s 4 November decision to leave interest rates unchanged at 0.1% caught markets off guard. “BoE Governor Andrew Bailey and Chief Economist Huw Pil had both been making hawkish comments in the past few weeks that suggested a rate increase was coming - and markets had priced that in,” he remarked, noting that the bank instead voted 7-2 to hold rates steady.

The BoE cited uncertainties about labour market conditions in forgoing a rate increase, Cousley said, noting that the UK economy still has some spare capacity. The central bank did, however, signal that rate hikes will be necessary soon, he added. “While the BoE sees inflationary pressures as transitory, it does project that inflation will rise to around 5% by next April, before starting to move down,” Cousley stated.

The Reserve Bank of Australia (RBA) also made headlines the week of 1 November, he noted, with officials abandoning their policy of yield-curve control. “This policy had been designed to keep the short end of the yield curve at 10 basis points,” he explained. However, the overall rhetoric from the RBA meeting was still very dovish, Cousley said, explaining that Australia’s central bank doesn’t see inflation rising to the midpoint of its 2% to 3% target range until at least 2023. “The long and short of this is that the RBA is still a ways from raising rates,” he stated.

China tightens restrictions amid COVID-19 outbreak

Switching to China, Cousley said that the country’s current COVID-19 outbreak appears a bit more concerning than the one seen last summer, leading to the imposition of some pretty tight travel restrictions in Beijing. He noted that there’s been a significant cancellation of flights in and out of the Chinese capital in the past week, with government authorities telling residents that have been traveling to stagger their return times to the city.

“With the Winter Olympics coming to Beijing in February, I think it’s highly likely that China’s zero-tolerance approach to COVID-19 outbreaks will be in place for several more months,” Cousley stated, “and I believe that this policy will continue to be a risk to the country’s economic growth.”

China’s highly leveraged property sector also remains a big risk to growth, he said, noting that although Evergrande Group has been able to make two recent payments, several other property developers are also facing debt woes. This is contributing to lots of stress in the property sector, Cousley said, with offshore Chinese high-yield market spreads soaring over the past week.

Importantly, however, this stress hasn’t spread to other parts of the Chinese economy yet, he remarked. “Right now, contagion appears to be ring-fenced within China’s property market,” Cousley observed. However, the situation is likely to result in a hit to Chinese economic growth in 2022, he said, with consensus expectations now calling for a growth rate of 5% or a bit lower - versus earlier estimates of 5.5% GDP (gross domestic product) growth. Currently, markets are waiting to see if the government will announce additional stimulus measures in order to cushion the economic impact of the country’s embattled property market, Cousley concluded.

Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.

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