The Reserve Bank of Australia will do what’s necessary to bring inflation down to its 2-3% target, Governor Philip Lowe said, in a hawkish message that helped send government bond yields soaring to a 10-year high.

Lowe, in an interview with ABC TV warned inflation could hit 7% by year’s end and is unlikely to slow until the first quarter of 2023. It’s “reasonable” to expect interest rates will rise to 2.5% from 0.85% now, he said, while expressing confidence households could manage higher debt repayments.


The Reserve Bank governor, Philip Lowe, has warned Australians to be prepared for higher interest rates, saying inflation will likely reach 7% by the end of the year and it must be brought under control.
In his first public appearance since the RBA raised the cash rate by a larger than expected 50 basis points at last week’s board meeting, Lowe said on Tuesday night he was predicting inflation to rise to 7%. That compares with current inflation of 5.1%.

“By the end of the year, I expect inflation to get to 7%,” Lowe said.
Lowe said the economy was in remarkable shape with the unemployment rate at a 50-year low, households having built up financial buffers of around $250bn and the number of people falling behind on their mortgage repayments actually declining.  

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RBA’s Hawkish Message Helps Send Australian Bond Yields Soaring. Governor Lowe says it’s reasonable to expect rates to hit 2.5%
Australian three-year yield rises to 3.65%, highest since 2012. 

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Analysts at RBC Capital Markets on Monday joined other brokerages in cutting their 2022 year-end S&P 500 target, trimming it by about 3.3% to 4,700 points, due to slowing economic growth.

HSBC and Credit Suisse cut their targets on the benchmark index in May following a market selloff over fears of a prolonged war in Ukraine and record high oil prices that are hurting global economic recovery from COVID-19.

“We are continuing to bake in a slower economic growth backdrop in 2022-2023, but not a recession,” RBC said in a note. The brokerage previously expected the S&P 500 to end 2022 at 4,860 points.


Uncertainty around the U.S. central bank’s policy move to check inflation which is running at more than three times its 2% goal, the Russia-Ukraine war, prolonged supply-chain snarls and higher Treasury yields have rocked global stock markets.

Several bank chiefs have recently sounded the alarm on fading consumer sentiment and demand due to record high inflation, with JPMorgan boss Jamie Dimon describing the challenges facing the U.S. economy akin to a “hurricane” down the road.

However, RBC analysts said small-cap companies were faring better on its sentiment and valuation model, with their earnings looking better than others.

“If it turns out that the U.S. avoids a recession and the U.S. equity market has bottomed, we’ll look back at SmallCap’s resilience in early 2022 as something telling us stocks had already priced-in the economic damage that was around the corner.”  

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Japan’s currency is the worst performer in G-10 this year. Increasingly hawkish Federal Reserve weighing on yen. The yen extended a twenty-year low against the dollar Tuesday, weighed down by the widening gap between yields in Japan and the US, stoking speculation over potential intervention. 

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The Bank of Canada indicated that persistent price pressures are making it more likely policymakers will need to raise borrowing costs to contractionary levels in order to keep inflation expectations anchored.

In a speech a day after the central bank raised its benchmark overnight rate by a half percentage point to 1.5%, Deputy Governor Paul Beaudry gave new guidance Thursday on how high borrowing costs could rise. The policy rate may now go to the top, or even above, what the Bank of Canada considers its “neutral range,” estimated at between 2% to 3%.

During their policy deliberations this week, Beaudry said officials discussed how price pressures continue to surprise on the upside and are broadening, with inflation poised to move even higher before easing.

“This raises the likelihood that we may need to raise the policy rate to the top end or above the neutral range to bring demand and supply into balance,” Beaudry said in prepared remarks of the speech provided to journalists. He was speaking in Gatineau, Quebec.
The comments will firm up market expectations the central bank may need to increase rates to levels that more actively slow economic growth in order to contain three-decade-high inflation.

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Sterling is in danger of becoming an “emerging market” currency as falling growth and growing risks cause investors to flee the pound, according to Bank of America. As of Tuesday afternoon in Europe, sterling was down 7% against the dollar year-to-date, trading just below $1.26 having been as low as $1.22 earlier this month.

Short positions have been mounting against the currency as the global economic challenges of the war in Ukraine, inflation, supply chain bottlenecks and slowing growth converge with domestic risks stemming from the Bank of England’s unique predicament and the fallout from Brexit.
In a research note Monday, BofA said further weakness can be expected in the pound through the rest of 2022.

He also dismissed comparisons between the monetary tightening paths of the U.S. Federal Reserve and the Bank of England, arguing that the reaction functions of the two central banks are different.

“The challenges facing the BoE are unique along with a supply dynamic that it remains wholly unwilling to discuss: Brexit. This has resulted in a confusing communication strategy: hiking rates against a sharply slowing economy is never a good look for any currency,” Sharma said.
“An alleviation of the current risk off environment and fiscal stimulus may provide some relief but the damage has been done and the outlook for GBP looks grim.”

The preferred means of capitalizing on sterling’s “epic” fall from grace for BofA is through the advance of the euro against the pound, BofA added. 

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This was echoed on Tuesday by George Saravelos, Deutsche Bank’s global head of FX research, who told CNBC that greater optimism about European growth, as well as the “non-linear” effects of the European Central Bank returning to positive rates, meant the euro is poised to outperform both the dollar and the pound.

“If you look at what was happening into U.K. inflows, they were going sideways and as soon as the ECB went negative you saw a big acceleration of inflows into the U.K. – purchases of, for example, U.K. gilts,” Saravelos said.
“As that dynamic changes and the Bank of England is much closer to stalling – it’s a reluctant tightness, so to speak – you should see euro-sterling significantly higher. We see it above 90 pence by next year.”

As of Tuesday afternoon, the euro was trading at just above £0.85.

“This carries with it two risks: overseas investors could repatriate part of this portfolio of U.K. assets on deteriorating confidence in the U.K. economy (asset allocation shift due to the end of negative interest rates elsewhere); or that the large stock of foreign holdings of U.K. assets will continue to weigh on the primary income balance,” BofA said.

“Whatever the reason, the external trade position will become an increasing focus for markets as the UK economy struggles under the weight of higher inflation and slower growth.”

U.K. assets are now more expensive than they were in 2021, when inflows to the country were significant, and the pound is increasingly considered less “undervalued” than models suggest, bank added.
The Bank of England is expected to continue raising interest rates to rein in inflation, after a fourth consecutive hike took its base rate to a 13-year high of 1% early in May. The Bank sees inflation to rise to roughly 10% this year as a result of the Russia-Ukraine war and persistent lockdowns in China.

Bank of America strategists are increasingly skeptical that the Bank’s defense mechanism can rescue the pound, however.

“Though not our central scenario, we think sterling finds itself in an increasingly invidious position, where central bank communication has been increasingly challenging; where imbalances are rising and where the specter of Brexit still looms large on the domestic political scene”. 

“Investors are increasingly discussing GBP as taking on emerging market characteristics whilst parallels to the 1970′s resonate as being one of the worst post-war decades for the UK.”

Bank of America added that the Wall Street giant is concerned that the “increasing politicization” of U.K. policy undermines the pound in ways that “would appear EM-like,” suggesting investors begin hedging for the pound to lose its status as a respected global currency. 

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The difficult position the Fed finds itself in spurred BlackRock, the world's largest asset manager with nearly $10 trillion under management, to downgrade US stocks to "neutral" on Monday.

"The Fed's hawkish pivot has raised the risk that markets see rates staying in restrictive territory. The year-to-date selloff partly reflects this, yet we see no clear catalyst for a rebound," BlackRock said. "If they hike interest rates too much, they risk triggering a recession. If they tighten not enough, the risk becomes runaway inflation. It's tough to see a perfect outcome." 

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And recent hawkish comments from Fed Chairman Jerome Powell last week signal that the Fed will do whatever it takes to stop the continued rise in inflation, as he still sees a strong labor market and resilient consumer as surviving a spate of rate hikes.
That quick pace of rate hikes by the Fed, combined with plans to reduce its balance sheet starting next month, means that it will be harder for central banks to come to the rescue and halt a growth slowdown in the economy by cutting interest rates and buying assets like it's done in prior periods of economic slowdowns, BlackRock said.
"We expect China's deteriorating economic outlook to be a drag on global growth – and we think consensus forecasts for China's 2022 GDP growth are likely to get revised down," BlackRock said. 

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The Bank of England needs to tighten policy further to fight rising inflation, but it’s also wary of acting too quickly and risking pushing the UK into recession, according to Chief Economist Huw Pill.

Pill, who has voted with the majority to hike rates at each of the BOE’s previous four meeting, told the Western Mail newspaper that he expects “over the coming months some further moves in the direction we have been seeing.”

“I personally think there is more that needs to be done in this transition from what has been a very supportive monetary policy for the economy really going back to the financial crisis, through the fallout from Brexit and the pandemic,” he said, according to the newspaper. “And we need to go not necessarily to a super restrictive stance, but to a stance that takes some of that support away and is more reflective of the fact inflation is higher and labor markets tighter.”

The BOE is grappling with an inflation rate that is at a four-decade high and predicted to go even high, and an economy that is forecast to slowdown as the cost of living crisis saps demand. That means there are risks if the bank acts too slowly, or too quickly, Pill said.

“When you think about that in terms of policy too much runs the risk that you fall into and get stuck in a deep recession, which is very costly and too little you run the run risk that inflation gets this self-sustaining momentum and runs away from the target,” he said.   

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The euro’s weakness on currency markets could threaten the European Central Bank’s efforts to steer inflation towards its target, ECB policymaker Francois Villeroy de Galhau said on Monday. The euro’s weakness makes imported dollar-denominated goods and commodities  like oil  more expensive, fuelling price pressures that have already driven euro zone inflation to record levels.

“Let me stress this: we will carefully monitor developments in the effective exchange rate, as a significant driver of imported inflation,” Villeroy told a conference at the Bank of France, which he also heads. “A euro that is too weak would go against our price stability objective.”

Villeroy said that a “decisive” ECB governing council meeting could be expected in June followed by an “active summer” on the monetary policy front.

“The pace of the further steps will take into account actual activity and inflation data with some optionality and gradualism,” he said.

Policymakers should “at least move towards the neutral rate”, he added, at which the central bank’s monetary stance is neither stimulating the economy nor holding it back. 

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Increase in savings and fixed mortgages weaken transmission. Former government adviser says higher rates needed for longer.
The Bank of England is being warned it may have to hike interest rates higher than investors expect, even as the risk of recession mounts, in part because it has lost much of its power to control. 

 

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 In a speech Thursday , Gravelle reiterated that rates need to rise further into the neutral range of 2 to 3% in order to cool domestic inflation and bring the economy back to balance.

“We are taking actions to normalize our policy rate quickly and are prepared to be as forceful as needed,” Gravelle said, according to prepared remarks.

Gravelle said the central bank may pause increases to interest rates at the neutral range if price pressures begin to reverse course, or if heavily indebted Canadian households reduce their spending by more than expected.

Conversely, the deputy governor also made the case for hiking borrowing costs above the neutral range if global supply chain issues persist, or parts of the domestic economy end up being less sensitive to higher interest rates than expected.

“We are not on a pre-set path of policy rate increases aimed at getting to a specific ‘terminal’ rate,” Gravelle said. 

The comments will firm up market expectations of a second jumbo rate hike at the bank’s next meeting on June 1, after a 50-basis point increase in April. Investors see Canada’s benchmark interest rate rising above 3% over the next 12 months in one of the most aggressive tightening cycles since the end of last century.

Speaking in Montreal, the deputy governor outlined how higher commodity prices, global supply chain issues, and the reopening of economies are pushing up inflation. Gravelle also said that the bank’s near-term forecasts for price gains are likely to be revised up, adding that “inflation pressures have been higher and more tenacious than we expected.”

 

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