Traders say that in some cases perceptions are seemingly changing on almost a daily basis, as central bankers struggle to balance the need to cut rates to stimulate growth with the need to increase them to combat inflationary pressures.
For instance, the consensus view that UK rates would fall further to counteract the risk of a damaging fall in the housing market was challenged with the release of minutes from the Bank of England’s monetary policy committee’s meeting on April 23. The minutes showed that although the MPC had then decided to cut interest rates by 25 basis points to 5%, the nine-strong committee was split three ways: two members, Tim Besley and Andrew Sentance, voted to keep the BoE’s key repo rate on hold, while one member, David Blanchflower, voted for a larger, 50bp cut.
According to Matt Sharratt, European economist at Bank of America in London, the decision reaffirmed "the BoE’s apparent reluctance to engage in rapid rate easing given concerns about the near-term inflationary pressures".
Sharratt adds: "The BoE minutes recorded that there was a split between those believing that the downside CPI risks in the medium term had risen in light of the deteriorating economic climate and those that were ‘less clear, but on the basis of the central outlook, thought it was nevertheless appropriate to implement some of the further easing that was implied by the February inflation report projections.’"
The MPC also noted that near-term inflationary pressures remained a concern. "In our view," says Sharratt, "the key debate for the majority is whether, and to what extent, the deteriorating economic outlook might lead to CPI inflation undershooting the 2% target in the medium term. The implication is that if the present inflation overshoot should prove more persistent than expected, then support within the present majority of six for a modest pace of rate easing may begin to fracture."
It is not just the BoE which is struggling to determine the correct path for its monetary policy. There have been a string of contradictory statements emanating from the European Central Bank, perhaps unsurprisingly given its traditional stance on the dangers of inflation but also its responsibility for keeping the eurozone economy on track.
Commenting on the release of eurozone producer manufacturing index (PMI) data, Sharrat’s colleague, senior economist Gilles Moec, says: "So far, the manufacturing sector in the eurozone has proved remarkably resilient to the combination of strong euro and slower US demand. This might have recently changed. The flash manufacturing PMI fell more sharply than expected in April to 50.8 in the eurozone, against a market forecast of 51.6, retreating from 52.0 in March."
Wage indexation
Moec adds: "However, the deterioration in the manufacturing PMI was offset by a surprising rebound in the services PMI, from 51.6 in March to 51.8 in April. The improvement came from Germany, with a whopping 2.8 point rise to 54.6, contradicting expectations of a fall to 51.5. German consumers are traditionally particularly allergic to inflation, and they have so far reacted to the spike in energy and food prices by keeping their wallets firmly shut... Such a ‘wage indexation’ mentality would only add to the concerns of ECB arch-hawk Axel Weber over the possibility of an inflation spiral. It would be far-stretched to substantiate such a scenario with just one piece of data, but this is certainly a risk that needs to be monitored, if only because a German/rest of the eurozone divergence would make the decision-making process at the ECB even more difficult... On balance, today’s data are consistent with the ECB staying on hold for a long period of time. The strong euro is now more clearly a source of difficulties, but the overall softening in economic activity in the eurozone is still very gradual. In a context of strong inflation and growing risks of second-round effects, cutting rates would likely send the wrong signal to price setters, in our view."