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CROSS-ASSET WEEKLY
22.10.2021

Excessive Rate Expectations for the ECB and Bank of England

Summary
Cross asset weekly pic
Given high and rising inflation expectations, calibrating an appropriate policy response is the top priority on central bankers’ minds. ECB members seem to take a relatively sanguine view of long-term inflationary pressures, and we expect the ECB to send a more dovish and bond-market friendly message at its upcoming meeting next Thursday, indicating that markets are pricing in too much inflation and an overly hawkish rate view. We also look at potential candidates to replace Bundesbank President Weidmann, following his unexpected resignation this week.
Meanwhile in the UK, the Bank of England, worried about unanchored inflation expectations, has shaken up domestic money markets. Implied policy rates have repriced substantially and indicate 100bp of tightening over the next 12 months. This has led to a marked underperformance of UK Gilts and a substantially flatter yield curve. We believe the move is excessive, given that there is little evidence of a wage-price spiral amid moderating growth rates, and forecast only two hikes over that period. Consequently, we would expect short-term yields to ease back and the Gilt yield curve to re-steepen again. Accordingly, we believe that the medium-term rate outlook will limit the upside potential for the British pound going forward.
Finally, we note that, the US Q3 earnings season is off to a solid start. Beat rates are above long-term averages, though weaker than in the first half of 2021. EPS growth is also looking solid at 47% (year-over-year). However, cyclicals’ earnings and earnings revisions are showing some weakness, partly resulting from the moderating macro picture.

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