Blackrock: ECB planned policy normalization underappreciates the risk of the energy crisis

A note from BlackRock a little earlier this week ICYMI. On the Fed:

  • The Fed’s updated “dot plot” of the Fed funds projection shows it’s ready to push rates to nearly 4% by next year (red line, left chart). This takes rates well beyond neutral of around 2.5% – the level that neither stimulates nor decreases economic activity. Yet the Fed continues to forecast trend-like growth (red line, right chart). Financial conditions are already rapidly tightening. And with growth slowing elsewhere and higher energy prices, we expect a deteriorating macro environment for the rest of the year and into 2023. The Fed isn’t looking for a recession, even though in our view one would be needed if it wanted to drive inflation

    Inflation is defined as a quantitative measure of the rate in which the average price level of goods and services in an economy or country increases over a period of time. It is the rise in the general level of prices where a given currency effectively buys less than it did in prior periods.In terms of assessing the strength or currencies, and by extension foreign exchange, inflation or measures of it are extremely influential. Inflation stems from the overall creation of money. This money is measured by the level of the total money supply of a specific currency, for example the US dollar, which is constantly increasing. However, an increase in the money supply does not necessarily mean that there is inflation. What leads to inflation is a faster increase in the money supply in relation to the wealth produced (measured with GDP). As such, this generates pressure of demand on a supply that does not increase at the same rate. The consumer price index then increases, generating inflation.How Does Inflation Affect Forex? The level of inflation has a direct impact on the exchange rate between two currencies on several levels.This includes purchasing power parity, which attempts to compare different purchasing powers of each country according to the general price level. In doing so, this makes it possible to determine the country with the most expensive cost of living.The currency with the higher inflation rate consequently loses value and depreciates, while the currency with the lower inflation rate appreciates on the forex market.Interest rates are also impacted. Inflation rates that are too high push interest rates up, which has the effect of depreciating the currency on foreign exchange. Conversely, inflation that is too low (or deflation) pushes interest rates down, which has the effect of appreciating the currency on the forex market.
    Read this Term back down to 2%. So we expect the Fed to change course once it becomes clear growth has stalled.

And, on the European Central Bank

European Central Bank

The European Central Bank (ECB) represents the central banking entity in the Eurozone that oversees monetary policy for the bloc. As a growing geographic and economic region, the eurozone now includes 19 countries, which rely on the euro as their national currency.The eurozone presently consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.In terms of monetary policy, the ECB and the national central banks together constitute the Eurosystem, which reflects the central banking system of the euro area.The ECB’s primary function is to maintain price stability in the eurozone and to preserve the purchasing power of the euro.Founded in 1998, the ECB is also responsible for providing both security and stability of the banking system and financial system within the EU region and within each member country.Furthermore, the ECB was also given a mandate to oversee the conduct of forex operations. This includes dealing with the holdings and management of the official foreign reserves of the euro area countries.How Does the European Central Bank Affect Forex? The ECB’s policies can have a substantial effect on the value of the euro, most notably through changes in interest rate expectations.As a broad-based example, when interest rates expectations rise, currencies tend to appreciate. When interest rates expectations fall, currencies tend to depreciate.For example, if the ECB keeps interest rates unchanged, but issues forward guidance that they may raise interest rates in the future, the value of the euro likely appreciates.The ECB primarily lowers interest rates when it is trying to stimulate the economy.

The European Central Bank (ECB) represents the central banking entity in the Eurozone that oversees monetary policy for the bloc. As a growing geographic and economic region, the eurozone now includes 19 countries, which rely on the euro as their national currency.The eurozone presently consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.In terms of monetary policy, the ECB and the national central banks together constitute the Eurosystem, which reflects the central banking system of the euro area.The ECB’s primary function is to maintain price stability in the eurozone and to preserve the purchasing power of the euro.Founded in 1998, the ECB is also responsible for providing both security and stability of the banking system and financial system within the EU region and within each member country.Furthermore, the ECB was also given a mandate to oversee the conduct of forex operations. This includes dealing with the holdings and management of the official foreign reserves of the euro area countries.How Does the European Central Bank Affect Forex? The ECB’s policies can have a substantial effect on the value of the euro, most notably through changes in interest rate expectations.As a broad-based example, when interest rates expectations rise, currencies tend to appreciate. When interest rates expectations fall, currencies tend to depreciate.For example, if the ECB keeps interest rates unchanged, but issues forward guidance that they may raise interest rates in the future, the value of the euro likely appreciates.The ECB primarily lowers interest rates when it is trying to stimulate the economy.
Read this Term:

  • How does inflation / growth trade-off play out elsewhere? We think the European Central Bank (ECB) will be forced to confront reality sooner because the euro area will feel economic pain sooner. The ECB’s planned policy normalization underappreciates the risk of the energy crisis pushing the euro area into recession. The ECB’s troubles are seen in the peripheral bond volatility that sparked an emergency meeting last week to help steady financial conditions across the euro area.

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