Fed hike gives ECB a welcome helping hand

US rate rise clears path for BoE’s Carney — but not right away

FRANKFURT, Dec 17, (RTRS): Just weeks after disappointing investors with smaller-than-expected stimulus, the European Central Bank has got a helping hand from the Federal Reserve with a US rate hike that could limit the need for further action of its own.

The Fed and the ECB are moving in opposite policy directions as the US economy strengthens while Europe struggles with tepid growth, high unemployment and anaemic inflation far from the ECB’s target despite its best efforts so far to boost it.

The US hike, the first in almost a decade, istarted weakening the euro — a move which if prolonged would be a double-blessing for the ECB as it boosted the currency zone’s exporters while simultaneously helping to kickstart inflation.

More importantly, the calm market reaction to Wednesday’s hike suggests investors accept divergence between the world’s top two central banks, allowing the ECB to hold a steady course.

“The ECB will to some extent be able to decouple financing conditions in the euro area from the US,” Dirk Schumacher, senior European economist at Goldman Sachs, said. “The divergence story will stay with us.” The ECB extended quantitative easing two weeks ago to prop up growth. But its move to shave 10 basis points off the deposit rate and extend but not substantially expand bond-buying was far less ambitious than expected, disappointing markets and pushing the euro more than 3 percent higher on the day.

Some of that is already being reversed, with the euro weakening around 1 percent since the Fed decision. Government bond yields of euro zone members like Germany, France, and Italy, which had risen after the ECB decision, edged down 6-8 basis points for 10-year paper on the back of the Fed’s move.

That was seen by some as a thumbs-up to the Fed and fixing what some investors saw as a misstep by the ECB: Rising US rates could in theory have raised European borrowing costs so a counterintuitive yield fall suggests ECB policy is increasingly detached from the Fed.

“We are not seeing any spillover of the US monetary policy in Europe and we will likely not see it because the rate hike was fully priced in,” Marco Brancolini, RBS European rates strategist, said.

“More importantly, euro rates are driven by US rates only in the very short term. In the long term, 10-year Bund levels depend on ... (ECB) monetary policy.”

Danske Bank predicted only a ‘slight upward pressure’ on euro zone debt yields in the coming six to 12 months.

Others noted that this disconnect would allow the euro to fall further against the dollar.

“There is the potential for a further devaluation in the euro and that’s the best thing that can happen to the euro zone,” Peter Bofinger, one of the ‘wise men’ that advise the German government on economic policy.

Although the ECB has repeatedly said it was ready to ease policy further if necessary, analysts polled by Reuters only see a 40 percent chance of further action next year.

Meanwhile, the first US interest rate rise in nearly a decade helps clear the way for a similar, long-anticipated move by the Bank of England. But even so, Governor Mark Carney will be in no rush to follow suit.

After years in post-crisis mode, the Fed’s decision marks the beginning of a return to normal monetary policy in the United States. Crucially for Carney, it allows him to assess how the US economy and markets react to costlier borrowing before making what will be a sensitive move of his own.

The British economy is likely to be among the world’s fastest-growing for a third year in a row next year and, just as in the United States, it has seen a drop in unemployment.

But faced with near non-existent inflation, sluggish wage growth and ultraloose monetary policy in Britain’s main euro zone trading partners, Carney has already stressed he would not necessarily move in step with his Fed counterpart Janet Yellen.

To be sure, he sent signals in July that a decision on whether to raise rates for the first time since 2007 could become clearer around the end of this year. And as late as October, some analysts were betting on the Bank of England (BoE) following hard on the heels of a US move.

But British data has since weakened and inflation, at a mere 0.1 percent, is still well below the Bank’s 2 percent target.

The next BoE announcement on rates — which have been at a record low of 0.5 percent since 2009 — is due on Jan. 14.

“I think it will be difficult for the Bank of England to tighten monetary policy ... until headline inflation reaches 1 percent again,” said David Page at AXA Investment Managers.

Aside from the inflation outlook, there are plenty of other reasons Carney might be cautious — not least Britain’s in-out referendum on its EU membership due by the end of 2017, and finance minister George Osborne’s plans for further spending cuts as part of his mission to run a budget surplus.

Both of these have the potential to affect economic growth, and influence the BoE’s assessment.

Carney has hinted on a couple of occasions in the past two years that the turning point might be nearing on rates. But as his predecessor Mervyn King — who was criticised for responding too slowly to the 2007-9 crisis — found out, the exact timing of any move is a delicate balancing act.

Carney’s previous hints of a British rate rise have been knocked off course by the twists and turns of the world economy, including the plunge in global oil prices which at one point sent British inflation tumbling to below zero.

With financial markets pricing in a rate hike in late 2016 to early 2017, but most economists in Reuters poll pointing to an earlier move in the second quarter next year, Carney’s challenge now is to make sure he gets his messaging right in the months ahead.

“The Bank of England has continually changed the goal-posts for us, as investors, to try and decide how monetary policy is being decided and what the ultimate point of lift-off for the UK will be,” Scott Thiel, global head of bonds, at BlackRock, the world’s largest asset manager, said before the Fed decision.

Fed chief Yellen spent months flagging that the US rate hike was on its way before Wednesday’s move.

By contrast, officials at the British central bank have in recent months limited themselves to saying they are watching and waiting to see how the country’s economy performs in the coming months, distancing themselves from clearer signals they sent previously that a rate hike might be coming.

Another key consideration for the BoE is the impact a rate rise would have on sterling, which before the Fed decision was up 4 percent against a basket of currencies and up 6.6 percent against the euro so far this year.

Giving British exporters some respite, sterling has fallen around 0.6 percent against the dollar since Dec. 1 as expectations for a US rate hike mounted.

But if the BoE changes its tone and signals it might follow the Fed soon, that could push sterling up further against the euro just as the European Central Bank moves in the opposite direction to provide more stimulus to the single currency area.