La BoE rompt les rangs

• While the Fed is open to a higher terminal rate, the Bank of England (BoE) “dares to differ”.
• Beyond a likely “fiscal paralysis” – which may not be entirely bad news given the state of the US economy – the mid-term US elections could herald some future headaches, even if another debt ceiling drama can be avoided.

Unless the data gets truly terrible on inflation next month, the Fed will probably go for 50bps “only” in December, but the key issue, as Powell said, no longer is how quickly but how far and for how long. While the Fed sought to control any overly dovish interpretation of their imminent shift to a more cautious pace of tightening by talking up the possibility of raising the terminal rate, the Bank of England chose to push the market to consider that it has been over-estimating the total amount of tightening needed to bring inflation back under control. This difference may stem from the BoE’s awareness of looming fiscal austerity in the United Kingdom (UK), which would make the Marginal Propensity to Consume (MPC) ready to take a measured risk with the exchange rate by diverging from the Fed’s rhetoric. Of course, if the United States (US) economy starts softening fast, any “policy gap” becomes easier to maintain. We look at the recent US labour market dataflow. It has become quite ambiguous, with signs of softness co-existing with persistent evidence of overheating. There is still no “smoking gun” there which could trigger a downward revision in the expected terminal rate.

The European Central Bank (ECB) President’s speech last week was on the hawkish side in our opinion. The message on a shallow recession not being enough to tame inflation on its own is understandable “in substance”, but the communication effect is quite striking: if a shallow contraction does not suffice, then a legitimate question to ask the ECB is whether it is actively seeking to engineer a deep recession by going far into restrictive territory.

If the Democrats this week lose the House, or both the House and the Senate, there are technical ways to avoid another “debt ceiling drama” if the Biden administration can make good use of the “lame duck session”. Yet, the main consequence of the mid-term elections may lie in the intensification of the political confrontation in the US in the run-up to the presidential elections of 2024, in particular on voting procedures.