Cut does not mean tightening for central bank note printers

(Bloomberg) – Global monetary policy is expected to remain very loose until 2022, even as central banks are on the verge of reducing their emergency support in the face of mounting inflationary pressures. Last week, the US Federal Reserve announced it would begin by cutting back on massive bond purchases as early as November and the Bank of England hinted for the first time that it might raise interest rates this year. Norway became the first developed economy to rise, and borrowing costs also rose in Brazil, Paraguay, Hungary and Pakistan.

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Behind the pivot is the feeling that inflation is proving more stubborn, with the Organization for Economic Co-operation and Development raising its forecast to post consumer prices up 3.7% in the Group of 20. in 2021 and 3.9% next year.

Supply chains are strained for everything from semiconductors to cars, food and energy prices are rising, some labor markets are already showing skills shortages, and demand picks up after shutdowns. At the same time, the global recovery is not secure, making it harder for central bankers as some even face the prospect of stagflation-lite in which inflation climbs and expansion slows in the middle. of the spread of the delta variant and with many of them still not vaccinated. Global manufacturers reported last week that activity continued to slow. There is also a discrepancy. The Bank of Japan last week gave no indication of a withdrawal of stimulus measures, while the People’s Bank of China pumped the most short-term liquidity in eight months into the financial system as the real estate giant struggling China Evergrande Group kept the markets on the alert. The bank pushed back on reduction suggestions and one official even raised the possibility of increasing its regular asset purchases once its pandemic program ends. Turkey weathered the global trend last week by cutting rates, albeit under pressure from its government.

And even the Fed has changed its strategy since the last rate hike, now claiming that it is okay with letting the US economy run a little warmer than traditionally in the hope that it will reduce unemployment and attract more unemployment. active population.

The bottom line is that while some central bankers in rich countries may be bracing for the brakes and many emerging markets are already tightening up will add net $ 1.5 trillion in assets to their balance sheets next year and that Global rates will only increase by 11 basis points over the next year to an average of 1.48%, still about 80 basis points below their pre-pandemic level.

The cumulative hike in global policy rates so far remains lower than previous hike cycles – meaning most central banks will remain supportive next year, according to analysis by economists at UBS Group AG. “Central bank policies remain on steroids,” said Jérôme Jean Haegeli. , chief economist at Swiss Re AG in Zurich, and previously of the International Monetary Fund.

Investors are nonetheless listening for a change of tone amid concerns that the price hike, previously seen as transient, now appears to have a longer shelf life.

According to the Fed’s preferred measure, US inflation was 4.2% in the 12 months to July, well above the central bank’s 2% target. The Bank of England now expects inflation to exceed 4%, also exceeding its target. Mohamed El-Erian, chief economic adviser to Allianz SE and columnist for Bloomberg Opinion, predicted that other central banks would soon be forced to follow the Bank of England in accepting a more realistic assessment of the future of the inflation.

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A blow to the economic outlook could see Fed rate hikes “sink into the long grass, with expectations rising from 2023 to 2024 or beyond. The tapering test is less stringent, and a start to the End of this year looks close to baking. Nonetheless, if the recovery stumbles, the Fed may need to make a course correction, introducing discretion into a process that markets expect to perform on autopilot.

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Others may soon change. Mexico and Colombia are expected to hike rates this week, while New Zealand and South Africa may also start to tighten before the end of the year. It is possible that central bank officials are deliberately spraying the inflation threat in an attempt to contain expectations. The warning of a structurally higher rate would only solidify the outlook, according to Teresa Kong, portfolio manager at Matthews International Capital Management LLC in San Francisco.

“That in itself could lead to higher inflation expectations, which can lead to a self-fulfilling prophecy,” she said. “The risk is that central banks will move on to tightening sooner than they signal. Whatever they do, central banks will need to be cautious, according to James Rossiter, head of global macro strategy at TD Securities. Among the risks he identified in a recent report to clients include overreacting to temporary inflation overruns, delaying tightening growth concerns until it is too late and increasing at the same time as inflation overruns. governments restrict fiscal policy. Monetary stimulus linked to Covid, ”he said. “Although well telegraphed, this process is unlikely to go as smoothly as central banks and markets hope.”

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