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BlackRock forecast on monetary policy: "Fear of course changes could fuel volatility"

ECB chief Mario Draghi plans according to own statement - contrary to Fed president Janet Yellen - in the short term no interest rate hikes for Europe. However, premature fear could fuel volatility in 2018, says Martin Lück, chief investment strategist at BlackRock.

Things are going up again: Our B lackRock Macro GPS has long been pointing to a rise in core inflation in the USA to 2 percent, as the graph below shows. The surprise dent in 2017 is a brief episode and we expect markets to have more confidence in the inflation outlook.

Why? Wages are slowly beginning to rise, and factors such as the change in the measurement of mobile data costs are gradually being removed from inflation data. We therefore expect higher US yields and favor inflation-protected against nominal bonds.

Prices in the euro zone should also rise slightly in 2018. However, we agree with the forecast of the European Central Bank (ECB), which expects inflation to remain below 2% at least until at least 2019. There is still reserve capacity in the euro area. We see similar trends in Japan. Therefore, both the ECB and the Bank of Japan (BoJ) should stick to their loose monetary policy over the coming months.

Growing interest rate gap

The gap between monetary policy and interest rates on both sides of the Atlantic should continue to grow in the coming months. Even under new leadership, the US Federal Reserve (Fed) will, in our view, push ahead with the shrinking of its balance sheet - and implement the three rate hikes forecast for 2018. A fourth interest rate step is conceivable if the monetary authorities expect increased price increases due to tax cuts.

Has this started the era of quantitative streamlining, that is, the reversal of asset purchases? Not quite yet. But markets will be sensitive to the first signs suggesting a move by the ECB or the BoJ.

We expect European and Japanese central bankers to continue buying bonds in 2018, but at a slower pace. The ECB has signaled that it will raise interest rates only after the end of its bond purchases. And the BoJ is likely to stick to its asset purchases and its return target for cross-country skiers - even if a new central bank chief takes over the helm in April.

In any case, investors expect further negative short-term interest rates in Europe and Japan by 2019. However, premature fear of monetary policy changes could fuel volatility in 2018.

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