Yesterday's statements by central bank representatives attracted a lot of attention. ECB chief economist Philip Lane said they have to be careful not to overreact to high short-term inflation because an aggressive reaction could lead to too little price pressure going forward. "It is critical not to rush into excessive monetary tightening, which could push inflation below the 2% target over the medium term," he noted. Lane also believes that in order to achieve their goals, policymakers must not underestimate the risks involved.
The debate about how to withdraw stimulus in the wake of the coronavirus pandemic intensified after ECB President Christine Lagarde took a tougher stance on monetary policy earlier this month. Lagarde said the central bank should not rush to end stimulus measures because the current monetary policy "cannot fill pipelines with gas, clear port congestion, or train more truck drivers."
These statements made it clear that not everything is in the hands of the central bank, so everyone should not rely only on active support measures from the regulator. The authorities need to cope with current problems on their own, and not through stimulus support programs.
Of course, the bond purchase program of the ECB will still end in the near future, but the question is whether something will be offered in return. Most likely, the degree of aggressiveness on the part of the European Central Bank will depend on this decision. Many politicians believe that the central bank will offer something because leaving the economy without financing at a time when it has just recovered from the pandemic can deal a hard blow to stock markets and, in general, to the pace of GDP recovery.
The Bank of Spain has the same view as the ECB as its governor, Pablo Hernandez de Cos, also called for a clear, gradual and predictable policy. De cos said stabilizing inflation around 2% over the medium term would allow for a "gradual normalization" of monetary policy, and recent indicators suggest that this stabilization is proceeding quite calmly and the current high inflation is a temporary phenomenon.
Meanwhile, the Federal Reserve took a different path and continues to follow it confidently. Cleveland Fed President Loretta Mester said she supports a rate hike next month and is committed to tightening policy more quickly if necessary to curb inflation. "I think it would be appropriate to raise the federal funds rate in March of this year and then continue to raise it in the coming months," Mester said. "If by mid-year I see that inflation is not declining as expected, then I will support the reduction of bonds from the Fed's balance sheet at a faster pace," she added.
Fed officials concluded that there is a need to start raising interest rates soon as inflation was creating real problems. During the meeting last January 25-26, most politicians agreed that if inflation does not fall as they expected, they would tighten policy at a faster pace than currently planned. This directly indicates the active actions of the central bank in case the situation worsens. The best example is the unscheduled meeting that took place last Monday, which, although did not end with serious changes, shows how determined the Federal Reserve is.
However, the meeting took place before the release of the latest labor market and inflation report, so it is possible that the central bank now has a completely different opinion on how to proceed further. In any case, investors expect at least 150 basis points of tightening in 2022, up from 75 basis points just a few weeks ago.
In terms of the Fed's balance sheet, which currently sits at $8.9 trillion, Mester reiterated that she would support the sale of mortgage-backed securities, but was silent on a specific time frame for the start of the balance sheet drawdown. Mester believes that moving away from mortgage-backed securities would help accelerate the return of portfolio composition to primarily Treasury securities, which would minimize the impact of balance sheet assets on the distribution of credit across sectors of the economy.
Mester also noted that inflation will remain above 2% this year and next, and that the FOMC will take appropriate action to bring this rate back under control.
Technical analysis for EUR/USD
The key level for today is 1.1380 because a breakdown will lead to a further rise to 1.1420 and 1.1460. Meanwhile, a drop below the level will lead to a dip to 1.1325, and then a further fall to 1.1280.
Technical analysis for GBP/USD
A lot depends on 1.3620 because a breakout could result in a larger increase to 1.3660 and 1.3700. Meanwhile, a dip below 1.3590 will lead to a fall to 1.3550 and 1.3520.
