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By GEOFFREY SMITH
with BEN MUNSTER, CARLO BOFFA and IZABELLA KAMINSKA
— Federal Reserve set to pause tightening cycle as CPI eases.
— ECB still expected to hike at policy meeting on Thursday.
— Gilts tumble as UK labor market stays red hot.
ECB 3.75% ⇡ — BOE 4.5% ⇡ — FED 5.35% ⇡— SNB 1.5% ⇡— BOJ -0.10% ⇣— RBA 4.10% ⇡— PBOC 3.65%⇣— CBR 7.5% ⇣ — SARB 8.25% ⇡
Good morning, everyone, and especially to you cricket lovers. The Ashes are nearly upon us, and the thrill of anticipation is almost enough — but not quite enough — to make your average Englishman forget that he’s living in a nightmarish wage-price spiral that ratchets higher every month. May’s labor market report showed average earnings rising at their fastest pace ever (outside of the pandemic), making more rate hikes from the Bank of England inevitable. Gilts had a wretched day.
Despite that, BoE Governor Andrew Bailey’s performance in the House of Lords reminded us of english cricketer David Gower in his pomp: fluent, entertaining and in places downright emphatic, while still giving the impression of never being more than one ball away from disaster. Fortunately for him, the bowling was kind, notably from Lord Mervyn King of Lothbury, who seemed to have volunteered to sub for the other side when they turned up a man short.
By comparison, Megan Greene’s pre-commencement hearing was like facing peak West Indies pace on a Barbados minefield, the missiles coming at her from every angle, with John Baron and Angela Eagle in the roles of Michael Holding and Malcolm Marshall. Greene can walk into the Bank on her first day and tell the rest of the MPC, Geoff Boycott-style, that if it weren’t for her, they’d already be 0 for 4.
PROGRAMING NOTE: Our senior finance editor, Izabella Kaminska, will be interviewing the Bank of England’s Jon Cunliffe on Thursday as part of POLITICO’S Global Tech Day. She’ll be sure to get an update on whether he still thinks there’s a 7 out of 10 chance that a digital pound will be adopted. You can sign up to view the livestream here.
— U.K. April GDP, industrial production, trade balance, 8 a.m.
— Federal Reserve interest rate decisions, 8 p.m.
— Fed press conference 8:30 p.m.
The Federal Reserve is set to refrain from raising interest rates later Wednesday, for the first time in 15 months. While there’s always the chance of a surprise, the bigger-than-expected drop in May’s CPI rate this week to 4.0 percent was enough to persuade all those in rates markets still betting on a hike to cut and run.
By itself, that is unlikely to convince the European Central Bank to follow suit on Thursday (for more detail on why, read Johanna’s preview here). Rather, it raises the odds that the differential between U.S. and Eurozone interest rates will narrow from here, at least until the eurozone economy goes sharply into reverse. The euro hit a three-week high in response.
It was a different story in the U.K., where Gilt yields surged to within a few pips of their October highs as record wage growth reinforced fears that the Bank of England is still behind the curve. In brighter news, two eurozone banks issued the first new additional tier 1 bonds since Credit Suisse’s were written off as part of its shotgun marriage with UBS.
“WHO CARES ABOUT THE GARBAGE I TALKED YESTERDAY?” is a quote (wrongly) attributed to Konrad Adenauer, the giant of postwar German politics, but Morning Central Banker believes it heard the Bank of England’s new Monetary Policy Committee member Megan Greene muttering the same to herself after an uncomfortable hour with the Treasury Select Committee (the feed dropped so we couldn’t do any lip-reading verification).
Forced onto the defensive over her previous advocacy for dual interest rates, Greene also had to recant her previous condemnation of Brexit (“The most damaging blow ever inflicted on the liberal, democratic international order”). This was downgraded to “a shock”, a concession that still left true believers John Baron, Harriet Baldwin and Andrea Leadsom visibly smoldering with the desire to root out Remainerist heresy.
From all angles: Before that, Greene had been taken to task by the Labour Party’s Angela Eagle for her inexplicable reluctance to dictate food prices to supermarkets and savings rates to commercial banks (“Oh hello, CMA! Didn’t notice you there!”). It was a far cry from the respectful lecture halls of Brown and Tsinghua Universities. Welcome to CBBS (Central Banking as a Blood Sport), Megan!
RIGHT TO HIKE: As for hints as to how she may vote from August when she joins the MPC, well, Greene was coaxed into saying that it was right to hike last time out, which puts clear blue water between her and Silvana Tenreyro, whom she is replacing.
GILTS TUMBLE ON RATE FEARS: U.K. government bond yields rose to their highest since October, when a fatally-misjudged budget by then-Prime Minister Liz Truss sent them skyrocketing.
Wage trigger: The trigger this time was the Office for National Statistics’ latest labor market data, which showed wage growth accelerating to the fastest pace on record in the three months through May (aside from the statistically distorted pandemic period). Average wages excluding bonuses rose by 7.2 percent on the year in the three months through April. Including bonuses, wages were up 6.5 percent, also a non-pandemic record and up from 6.1 percent a month earlier. The jobless rate fell to 3.8 percent of the workforce as employment surged.
Behind the curve: The numbers were a resounding one-fingered salute to the BoE’s previous calls for wage restraint, and stoked fears that it simply isn’t getting on top of inflation (Bailey repeated to the Lords later that it would take much longer to come back down than the Bank had first expected). City analysts had expected a hot report, due to the 10 percent rise in the National Living Wage that kicked in at the start of April. However, they were surprised by how well the financial sector had done in this year’s bonus round. Clearly, the dictum of UBS’s Paul Donovan that “the first rule of profit-led inflation is: you do not talk about profit-led inflation” holds true. Your move, Tesco and Sainsbury’s!
AT1 REOPENS FOR BUSINESS: European banks are coming back to the market for Additional Tier 1 bonds, perpetual instruments that banks use to beef up their capital position. BBVA and Bank of Cyprus became the first institutions to tap the segment for the first time in almost three months, after it was tarnished by the hasty and legally disputed resolution of Credit Suisse.
Oversubscribed: BBVA’s €1 billion issue was covered three times over, a sign that investors were prepared to trust ECB assurances that they won’t ever do the same as their Swiss brethren. Swiss regulator Finma had wiped out AT1 holders in their haste to stop contagion from Credit Suisse’s collapse. The Swiss action went against expected practice, by allowing shareholders to receive some compensation from the buyer, UBS. Unsurprisingly, demand for AT1s dried up after that.
UNCONVINCED: The ECB’s top bank supervisor Andrea Enria said he’s not convinced that higher statutory liquidity requirements are the answer to the problems raised by the March banking panic in the U.S. Speaking at a Goldman Sachs event in Paris he said that supervisors should rather identify banks prone to runs and ask them to keep higher liquidity buffers. Adding statutory requirements would “only make regulation more complex and easy to be circumvented,” he said.
THE RELUCTANT AI WATCHDOG: The European Central Bank is one step closer to getting legal powers to police how banks use might use artificial intelligence to issue loans. Only thing is, the Frankfurt-based institution doesn’t really want all the responsibility. The European Parliament today is scheduled to vote through MEPs’ version of the AI Act, as part of an EU bid to regulate how the bloc’s companies use the technology. The rules rope in financial companies, including banks, which in turn ropes in the ECB’s supervisory arm.
Nothing is set in stone. Legislative negotiations with the Council are still needed before the final EU legal text is solid. But there is a risk that the ECB could be forced into a dual supervisory role that guards against financial instability while also protecting citizens from the potential evils of AI.
This is how it breaks down. AI can help banks speed up the vetting process for borrowers, depending on personal information that they feed into the machine. The ECB has an interest in keeping track of who the banks’ AI is handing money out to, so that robots don’t just issue loans to anyone who asks for one — like criminals or dodgy companies. What the ECB is not interested in doing, is checking whether banks’ AI refuses to give loans to people based on physical attributes, for example, such as gender or race. That goes beyond its legal mandate. The central bank even said as much in its opinion of the bill. “The ECB’s tasks should be limited to the prudential supervision of credit institutions,” the opinion said. “They should not include the supervision of products for the purpose of ensuring consumer protection.” If MEPs have their way, the ECB might not have a choice.
For those who are curious about the rest of the bill, President Roberta Metsola and the MEPs who shepherded the act through parliament, S&D’s Brando Benifei and Renew’s Dragoș Tudorache, are holding a press conference at 1:30 p.m.
TOKEN EASING: A token rate cut by the People’s Bank of China sparked a brief rush of excitement — at least until people realized that it was only validating the messaging of the last couple of weeks.
Virtuous signalling: The PBoC cut its seven-day reverse repo rate by 0.10 percentage points to 1.9 percent. The effect was purely symbolic, given that the operation involved less than $300 million, but the signal was clear enough. Over the last couple of weeks, state-owned commercial banks have all been dutifully cutting their deposit rates in an effort to encourage Chinese consumers to spend more after clear guidance from Beijing. However, data out on Tuesday underlined how hard that will be in the current environment. M2 money supply, new loans and total social financing — the broadest measure of Chinese credit growth — all grew by less than expected in May.
IS THE KETCHUP EFFECT REAL? George Saravelos, head of FX research at Deutsche Bank, believes supply-side factors make this economic cycle different to all the ones we’ve seen since the 1970s. “Measures of bottleneck inflation have not only unwound the entire spike from Covid but are now sitting at the lowest level since records began in the mid 1990s,” he wrote in a morning note to clients, adding “the ‘ketchup effect’ in the goods sector seems to be in full swing.” That’s the idea that once unclogged, pandemic-induced frictions will ease and allow the economy to respond much more fluidly to increases in demand.
Hey, maybe, inflation’s … a good thing? Saravelos also picks up on the inconsistency between the rates market pricing interest rate cuts (and therefore, implicitly, a recession) and the equity market, which is continuing to rally. But, he adds, it is possible for both to happen at the same time. Likewise the disconnect between ongoing market expectations for unemployment to rise and a recession before it has actually happened, seems equally glaring. A full-employment recession in the making?
In other ketchup news: “A more likely explanation for food price inflation is the lagged transmission of the big international supply shocks,” Bank of England MPC member Swati Dhingra said in a speech on Tuesday with respect to the supposed “greedflation” effect that has caught the media’s attention. Though nobody can be sure, she added, because there’s a lack of data about the country of origins of imported goods. “In other words, because a lot of the tomato ketchup we consume come from abroad, the price charged by UK producers for their ketchup is an insufficient metric for assessing the evolution of consumer prices of ketchup,” she said.
“I know that transient, transitory, temporary is not the word to use these days…” Bank of England Governor Andrew Bailey, to the House of Lords Economic Affairs Committee on Tuesday.
“A number of other central banks have come up to me and said ‘I’m glad you went first doing that’, because it was quite challenging to work out how to make the parts fit together.” — Bailey again, on the resolution of the Gilt market volatility episode last October.
“We solved the Gilts quite quickly, actually … those Gilts quite quickly.” Bailey again, correcting himself halfway through his sentence after remembering what was happening in the Gilt market as he spoke.
“I don’t think that case has been made, but I’m very clear that we have to test it — since it has been asserted — that the bail-in plan structure doesn’t work. That’s an important point coming out of Credit Suisse.” Bailey, ibid.
“Real average weekly earnings are same today as in November 2005. A completely unprecedented period with no earnings growth. Hard to compare but likely this has not happened over any comparable period since [the] Napoleonic wars. — Paul Johnson, director of the Institute for Fiscal Studies, via Twitter.
“The risk that you make a monetary policy mistake has gone up,” said former Fed governor Jeremy Stein to the WSJ on Tuesday.
— Primary RTGS systems have average $1.65m in operating costs (Central Banking)
— Brics common currency would be no threat to the dollar (OMFIF)
— European gas jumps over 15 percent as key Norway sites extend outages (Bloomberg)
— Regulators set to ban credit-sensitive Libor replacements (IFR)
— Bunge, Viterra will merge to form $34 billion agri-trading powerhouse (Reuters)
THANKS TO: Ben Munster, Carlo Boffa, Bjarke Smith-Meyer and Izabella Kaminska
(Editor’s note: this is intended as a selective list, giving precedence to European events)
WEDNESDAY, 14 June
U.K. April GDP, industrial production, trade balance, 8 a.m.
ECB May long-term interest rates, 10 a.m.
Eurozone April industrial production, 11 a.m.
U.S. May PPI, 2:30 p.m.
Federal Reserve interest rate decisions, 8 p.m.
Fed press conference 8:30 p.m.