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Banking

Bond Outlook by bridport & cie, January 19 2011

Struggles are emerging between governments nurturing weak recoveries and central banks wishing to dampen inflation. Bond markets may encourage central banks in raising rates, the BoE first, ECB later.

Bond Outlook

Inflation is climbing and, with it, the pressure on central banks to raise rates. The BoE are likely to tighten first, followed by the ECB. The inflation is “cost-push”, arising from increases in the prices of crude, foodstuffs, steel, and the like. It is strange that the USA is not seeing similar inflationary pressure, especially as the USD has weakened so much, but that may just be a matter of time, as the steepening of the USD yield curve suggests.

 

Higher interest rates are the last thing that governments want while recovery is so fragile. That would suggest a certain tension between European governments and their central banks. Although governments can scarcely admit it, higher inflation does of course carry with it the attraction of reducing debt to GDP ratios. Pay lip service to the official target rate of 2%, but do not insist too much!

 

If there is a struggle between central banks and governments, it may be resolved by bond markets. They are pushing up longer-term yields, and there will come a point when anchoring overnight rates so low may help increase bank profits, but does little for the rest of the economy.

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