Global shift in monetary policy

Soaring inflation is prompting central banks around the world to tighten their monetary policy. Many have either already decided to hike interest rates or are poised to do so in the coming days. One notable outlier is Japan, which is keeping its monetary policy in ultra-expansionary mode.

Most countries now raising interest rates to combat inflation

On Tuesday 7 June, the Reserve Bank of Australia (RBA) raised its key interest rate from 0.35 to 0.85 per cent, the country’s biggest rate hike in 22 years. It was only as recently as May that the rate had been increased for the first time in this cycle, by 25 basis points. Further hikes are on the horizon, and the key interest rate is likely to sit at around 3 per cent by the end of the year. Annualised inflation in Australia reached a twenty-year high of 5.1 per cent in the first quarter of 2022, with 6 per cent forecast for the second quarter. The rises in the price of energy, food and rents have been particularly acute.

In the middle of last week, the National Bank of Poland (NBP) raised its key interest rate by another 75 basis points to 6.0 per cent. With the labour market tight and inflation at an elevated level, further hikes are likely to follow. Poland’s interest rate could be as high as 7.5 per cent by the end of the year. Despite the war in Ukraine, Polish GDP climbed by 8.5 per cent in the first quarter of 2022, while wage growth came to just over 14 per cent in April. The rate of inflation reached 13.9 per cent in May.

Wednesday, 8 June also saw the Reserve Bank of India raise its key interest rate, by 50 basis points to 4.9 per cent. Inflation in India currently stands at 7.8 per cent, and it is the poorest in the country who are suffering the most. This inflation is primarily a reflection of the supply-side price shock in the food and energy sectors. The Central Bank of Chile got in on the action as well, lifting its key interest rate by 75 basis points to 9 per cent after having already hiked it by 125 basis points in May. The market expects Chile to see two more rate hikes before 2022 is out and for it to have an interest rate of 9.75 per cent by the end of the year.

Central banks' interest rate policy shift in full swing

Most central banks are raising their key interest rate

Central banks' interest rate policy shift in full swing
Source: Bloomberg, as at 10 June 2022

ECB also signals first rate hike and quantitative tightening

At its meeting on 9 June, the ECB announced that it will terminate the net bond purchases under its asset purchase programme (APP) at the end of this month and raise the key interest rate by 25 basis points in July. This will be the eurozone’s first rise in interest rates in eleven years. Another hike, potentially an even higher one of 50 basis points, will follow in September if there is no improvement in the medium-term inflation outlook. There is little doubt that this ‘normalisation’ of monetary policy is being driven by the current very high levels of inflation and inflation expectations for the future, some of which indicate further sharp price rises ahead. The ECB anticipates an average inflation rate of 6.8 per cent for the euro area in 2022, while Union Investment’s economists are predicting 7.3 per cent. The central bank’s statements could be interpreted as hawkish. Union Investment’s experts can imagine a scenario in which interest rate hikes in the eurozone this year and next are larger and greater in number than previously expected. The question is why the autopilot setting that applies to September should not also apply to subsequent path of rate hikes. The inflation ‘surprises’ anticipated by Union Investment over the next few months, relative to the ECB’s June guidance, should do enough by themselves to prevent medium-term inflation expectations from weakening significantly.

Clear signals from the US central bank

The Fed meets on Wednesday, 15 June. Its representatives have already made it clear that they will be looking to raise the key interest rate to a neutral level as quickly as possible so as not to pour further fuel on the inflation fire. Union Investment therefore expects the Fed to hike the base rate by 50 basis points both in June and in July, and by 25 basis points in each of September, November and December. The target range for the Fed funds rate would then be 2.5 to 2.75 per cent at the end of this year. After a further rise at the start of 2023, the cycle of interest-rate hikes is then likely to end with a target range of 2.75 to 3.0 per cent. The Fed’s passive trimming of its balance sheet will also start in June, with a target reduction of no more than US$ 95 billion per month to be reached in September. US inflation surprisingly climbed to a new annual high of 8.6 per cent in May, mainly due to a sharp rise in energy prices. By the end of the year, however, it is set to fall back below 6 per cent.

Bank of England remains on course

Union Investment expects the BoE to raise interest rates by 25 basis points on Thursday, 16 June. Another hike by the same amount is set to follow in August. Since December 2021, the BoE has been gradually phasing out its ultra-expansionary monetary policy in order to dampen inflation expectations and avert a wage-price spiral. Following interest rate hikes in December 2021 and in February, March and May 2022, the key interest rate for the UK currently stands at 1.0 per cent. The BoE is also likely to start actively reducing its holdings of government bonds by the beginning of 2023 at the latest.

Dovish Bank of Japan an outlier

The meeting of the Japanese central bank is scheduled for Friday, 17 June. The BoJ’s ultra-expansionary monetary policy now makes it the outlier among the major central banks. Union Investment does not anticipate any substantive change to this ultra-loose policy in the near future, either in the shape of a hike in the key interest rate or an end to yield curve control. This is primarily because of the level and type of inflation prevalent in Japan, where inflation is not only less steep than in other industrial nations, but also has more of an ‘imported’ character, with little price pressure originating from within the domestic economy. Wage growth is also behind the global average and inflation expectations remain below the BoJ’s 2 per cent target.

 

As at 10 June 2022.

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