The Global Radar Screen 04/1/11

Posted April 1, 2011 by PEllis

[private][private]Overview—The ECB Leads But Will Others Follow?

Investors fully expect the ECB to carry through on their promise to hike rates 25 bps at the upcoming meeting next week. Increasingly, it appears that the ECB is not framing this as a “one and done,” but the beginning of a longer-term policy normalization. Unable to extricate itself from unconventional policy easing, complicated by a need to support the market from the burden of the sovereign debt crisis, the ECB has instead little alternative but to begin unwinding the conventional policy easing. This is happening in an environment of subpar growth and tightening fiscal policy in most if not all nations in the region. The rise in oil prices, while inflationary, also serves as a drag on consumer incomes, which could in turn slowdown GDP growth even more. While the BoE is expected to keep policy on hold again, the calls within the MPC are growing to tighten policy. While the UK has a more serious inflation problem than the ECB, growth appears fragile and the fiscal policy has turned sharply restrictive. Nonetheless, investors look for policy rate hikes later this year. The big question mark is the US. While the hawks are talking about the potential need to rate hikes late this year, even one dove is talking about cutting back on QE as of the first baby steps needed to reverse accommodative Fed policy. We have been there before in early 2010 when markets braced for the Fed to undertake its long awaited exit strategy (Chart 1). Remember the Fed hiked the discount rate in February, a purely “technical move,” which nobody really believed was technical. The Fed ended up with some egg on their face as the recovery stumbled and they had to make a u-turn and “exit the exit” leading to QE2.

radar_screen_040111[/private][/private]