Geoffrey Smith 

Investing.com — Financial markets are in for a decidedly mixed bunch of early Christmas presents when three of the world’s most important central banks meet within the space of barely 24 hours this week.

The , the and are set for meetings of varying degrees of drama: the Fed is likely to announce a faster phase-out and – by implication – an earlier start to the new cycle of interest rate hikes than it had signalled at its last meeting. For the first time, the ECB must decide whether to reimpose certain forma limits on bond buying. The Bank of England has to make a choice between allowing inflation expectations to get out of control and raising interest rates at a time that a new wave of Covid will slow down the economy.

(As a coda the will also host its regular policy meetings on Friday. But since Japan is not yet free from the hold of deflation Japan’s chances of any policy tightening seem close to zero.

Consensus forecasts suggest that the Fed will announce its intention to run its asset purchases down from $120 billion a month down to zero probably no later than the end of March – a much faster withdrawal of stimulus than in the previous cycle. This would pose a challenge to the markets, which have become accustomed to high levels of liquidity support. This would open the door to a second interest rate increase in the middle next year.  The reasoning is simple: rates are rising at the fastest rate they have been in 10 years and at the highest rate since 1982.  Both of this month’s reports have shown broad-based price rises and strong monthly dynamics, undermining arguments that ugly headline numbers are just the result of distortive base effects from a year earlier (even if the pandemic is still wreaking havoc with the practice of seasonal adjustment).

The Bank of England may go further still – although the chances are now firmly that it won’t. Markets had more or less priced in a 15 basis point increase in the Bank’s key rate to 0.25% before the Omicron variant of Covid-19 arrived in the U.K.  

With the government now tightening its guidance on social distancing again, even the Bank’s hawks have suggested that it can afford to wait to see how bad things get with Omicron before it pulls the trigger. That’s despite the fact that annual inflation , and market rates imply medium-term expectations of inflation running at over 4%. 

In Frankfurt, however, the ECB is taking a less relaxed approach. The Eurozone has seen inflation rise, however it is expected to fall by the beginning of next year, as the two large tax hikes in Germany from a year earlier are eliminated. Despite the inability to obtain timely data about Eurozone wage levels, exact comparisons are difficult. However, ECB officials maintain that the level of wage pressure is not sufficient to create a true wage-price cycle.

The ECB’s dilemma will be – as so often – an internal one. At the start of the pandemic, it had suspended its own self-imposed rules on how far it can intervene in government bond markets, creating a ‘Pandemic Emergency Purchase Program’ that finally gave it full flexibility to support the weaker or more indebted members of Europe’s currency union.

That program is set to expire at the end of March, and the bank’s hawks are keen to restore some kind of constraint on its bond-buying. Reuters polled analysts this week and found that the bank will continue to buy 40 billion euro bonds per month until next year. In 2023, rate hikes will not be expected.

Holger Schmieding (chief economist at Berenberg Bank Berlin), stated in a note that the ECB is able to afford to wait. While labor shortages are real, they’re not as severe as those in the U.S.A. Job guarantee schemes in the region have led to less job shedding. And as the Eurozone didn’t pump as much money into households’ wallets early in the pandemic, so inflation is rising less rapidly now.

As a result, the ECB is – in contrast to the Fed – unlikely to ‘retire’ the word ‘transitory’ from its description of inflation on Thursday. The 2022 year will see a wider policy gap between the ECB, its peers and the Fed. This is expected to continue downward pressure on the for the foreseeable.