Unsurprisingly, the 16 June meeting of the Bank of England’s Monetary Policy Committee (MPC) led to a further increase in its policy rate, the fifth consecutive 25 basis point increase, taking it to 1.25%. This tightening of monetary policy, relatively modest when compared to the Fed’s 75bp hike, aims to control inflation, which is continuing to rise steeply (2.5% m/m NSA in April, giving a year-on-year figure of 9%), without putting excessive constraints on an economy already hit by the inflation shock.
After an unprecedented contraction in activity in 2020, the strong rebound in 2021 did not allow South Africa to return to its pre-crisis level of GDP contrary to most emerging economies. In 2022, activity should remain subdued and growth below 2% in the medium term. The economic outlook remains largely constrained by the need for fiscal consolidation in order to contain the high risk of debt distress, the tense socio-political climate, and structurally by strong infrastructure constraints, first of which the electricity supply. The shock induced by the conflict in Ukraine is also exerting significant pressures that could make fiscal consolidation efforts difficult
At its 10 March meeting, the ECB paved the way for raising its key deposit rate, although the timing of the first rate increase remained uncertain at the time: the odds of a September move had declined compared to a few weeks ago and July was excluded, which left December. The wait-and-see approach still seemed appropriate given the increasing downside risks to growth, aggravated by the current inflationary shock, the war in Ukraine and China’s zero-Covid strategy. Yet economic data reported in the meantime, as well as the hawkish tone of several ECB members, seems to have accelerated the tempo. Concerning data, it is the combination of high inflation, a weak euro and relatively resilient growth that has moved forward the lift-off date.
Over the past year, growth in the M2 measure of money supply in the USA1 has slowed from 27.1% y/y in February 2021 to 9.5% y/y in March 2022. This has mainly been due to the moderation in purchases, by the Federal Reserve (Fed) and banks, of Treasuries (blue bars) and mortgage-backed securities (MBS, hatched green bars). With the Fed having ended its net purchasing at the end of February 2022, the effect of QE was even smaller in Q1 2022. Since Q2 2021, the Fed’s repo arrangements with money market funds (light grey bars) have also resulted in the (temporary) destruction of money2. Other factors have pulled in the opposite direction
Elevated inflation, if left unaddressed, could cause a de-anchoring of inflation expectations, an increase in risk premia, greater price distortion and hence longer-term costs for the economy. Although at first glance, central banks face a dilemma - hiking interest rates to lower inflation at the risk of causing an increase in unemployment or focusing on the labour market and accepting the risk that inflation stays high for longer -, they can only choose between acting swiftly or face an even bigger challenge later to bring inflation back under control. Recent statements by officials of the Federal Reserve, the ECB and the Bank of England acknowledge the need to act but their decisions and guidance are very different and reflect the differences in the macro environment.
At first glance, the significant depreciation of the euro looks like a blessing for the ECB. Via its mechanical effect on import prices, it should remove any remaining doubt about the necessity of hiking the deposit rate. However, upon closer inspection, there is concern that the weaker euro, through its effect on inflation and hence households’ purchasing power, will weigh on growth. This would warrant a cautious approach in terms of policy tightening. On balance, a deposit rate hike in the second half of the year looks like a certainty, but the real question is about the scale and timing of subsequent rate increase. This will depend on how the inflation outlook develops.
The Spanish housing market is building momentum again after its deep correction between 2008 and 2013, which erased part of the excesses created over the early 2000s. In 2021, transaction volumes hit their highest level for twelve years. House prices have been growing at an average of 5% per year over the past six years. Housing activity is now benefiting from multiple sources of support: the post-Covid economic recovery, higher levels of household savings, growth in employment, low borrowing rates. Rising housing prices are driven by limits on housing supply, which are likely to persist, given rising construction costs as a result of higher materials expenses
With inflation soaring, the US Federal Reserve announced that it would accelerate the process of normalising its monetary policy. Held near the lower zero bound until March, the key policy rate should rise to roughly 2% or even higher by the end of the year. The Fed will also reduce the size of its balance sheet. Operating at full employment, the US economy seems to have recovered sufficiently from the health crisis to pass muster. Yet it is still sensitive to credit conditions and is not immunised against the impact of the war in Ukraine.
While the US Federal Reserve has begun raising its policy rate, the Bank of Japan continues to pursue a very accommodating monetary policy. The sharp depreciation of the yen leaves the BoJ less manoeuvring room to pursue its yield curve control policy. Some adjustments in its policy are expected. Economic support – both monetary and fiscal – will be maintained in 2022 in an environment that is especially tough for Japanese industrial companies, hard hit by global supply chain disruptions and the economic slowdown in China.
The war in Ukraine compounds the ECB’s task of balancing the fight against inflationary risks with the need to support growth. At the monetary policy meeting on 10 March, inflation was the predominant concern and the central bank announced that net securities purchases under the Asset Purchase Programme (APP) would probably end in Q3. This paves the way for the first increase in the key deposit rate, although the timing of the move is still highly uncertain. The inflationary shock is spreading while growth faces ever greater threats. Even so, pre-existing cyclical momentum, excess savings, investment needs and fiscal support measures should all help ease the risk of stagflation.
Unlike many central banks around the world, the Moroccan monetary authorities decided to maintain their key rate unchanged at 1.5%. Although inflation is accelerating, the surge is recent and relatively mild. In 2021, consumer prices rose at an average annual rate of only 1.4%. In February 2022, they were up 3.6% y/y and the situation will only get worse given the pressures on global commodity markets and the drop-off in national agricultural production. Three quarters of the acceleration in inflation in recent months reflects higher prices for food (+5.5% in February 2022) and transport (+6%), essentially due to external factors. Excluding these two categories, the growth in prices was less than 2%. Domestic pressures are mild
Although the war in Ukraine is casting shadows on the global economy, the Federal Reserve announced that it would rapidly normalise US monetary policy. The Fed’s main arguments for taking action include surging inflation, which is also spreading widely, as well as tight labour market conditions and tensions over wages. As the self-sustaining nature of price increases is still open for debate, the projected tightening of monetary policy looks surprisingly strong. In an economic environment accustomed to cheap borrowing costs, the Fed’s move is not without risks regarding the future path of activity.
The FOMC has started a new tightening cycle and its members project 6 additional increases in the federal funds rate this year and 4 more in 2023. This hawkish stance is unsurprising. After all, the policy rate is very low, inflation is exceptionally high and the economy is strong. Given the Fed’s dual mandate, the pace and extent of rate hikes will depend on the evolution of inflation as well as the unemployment rate. Previous tightening cycles suggest that concerns about the risk of an increase in the unemployment rate have played an important role in the decision to stop hiking. The central bank will have to hope that inflation has dropped sufficiently by the time that this risk would re-emerge.
Colombia’s public finances have come under the spotlight in recent years amidst recurrent adverse external shocks, rising social spending pressures, ongoing challenges in raising revenues, persistent (optimistic) biases in fiscal planning and, as of late, the back loading of fiscal consolidation plans following the Covid-19 shock. The rapid progression of the public debt ratio and the capacity for future policy adjustment have, in particular, become points of concern and have, since the summer 2021, materialized in Colombia losing its investment grade status
Since its launch, the ECB’s asset purchase programme has had, through various transmission channels, a significant impact on financial markets, activity and inflation. In recent months, doubts about the positive effects of additional purchases and concerns about possible negative consequences have increased. Against this background, the ECB has cut the link between the timing of the end of net asset purchases and the rate lift-off. This is a welcome decision that increases the governing council’s optionality. The new staff macroeconomic projections remind us of the pervasive uncertainty we are facing. In such an environment, monetary policy can be nothing else than data-dependent.
The latest monitoring report by the Basel Committee on Banking Supervision (BCBS)1 shows that despite very accommodating monetary policies, the immediately available liquidity position of the big American banks did not improve between Q4 2019 and Q2 2021, unlike that of the big European banks2. According to the first published data, the average short-term liquidity ratio, the Liquidity Coverage Ratio (LCR)3 was 116% for the American G-SIBs in Q4 2021, compared to 119% in Q4 2019, while that of the European G-SIBs was about 173% and 141%, respectively. In both cases, the average ratios were still significantly higher than the minimum prudential requirement of 100%
Concerning the Italian economy, now that the presidential election is behind us, attention has focused again on the risks associated with surging inflation and the upcoming start of the normalisation process of ECB monetary policy. 10-year Italian government bond yields have risen by nearly 50 basis points since early February, and they could reach the 2% threshold very soon.
In the UK, like elsewhere, the upsurge in inflation is proving a constant source of surprise, and is prompting the central bank to act. Annual inflation is currently over 5% and the Monetary Policy Committee (MPC) expects it to hit 7% in April, its highest level for three decades. In response, the Bank of England is raising interest rates. Set at 0.1% during the crisis, its base rate was raised to 0.25% in December and then by a further quarter-point in February. Further rate hikes will follow, since the MPC, in line with market expectations, is aiming to increase the base rate to 1.50% by mid-2023.
Despite a significant improvement in macroeconomic indicators over the past five years, foreign currency liquidity remains a major source of vulnerability for the Egyptian economy. The net foreign asset position of commercial banks has steadily deteriorated over the past year and was in deficit by USD10 billion in December 2021, by far its lowest level for a decade. Meanwhile, gross currency reserves at the central bank grew only very slightly over the year. This deterioration of the external position of the banking system as a whole reflects that of the external accounts. The current account deficit is increasing following a sharp rise in imports
Based on Christine Lagarde’s latest press conference, it is clear that the ECB’s Governing Council view on the inflation outlook has evolved quite significantly. Since the December meeting, upside risks to inflation have increased, raising unanimous concern within the Council. Financial markets interpreted this as a signal that the first rate hike might come earlier than previously expected and bond yields moved significantly higher. The ECB’s forward guidance, which can also be considered as a description of its reaction function, suggests a rule-based approach to setting interest rates with clear conditions in terms of inflation outlook and recent price developments. In reality, a lot of judgment will be used as well
In his press conference last week, Fed chairman Jerome Powell was very clear. Based on the FOMC’s two objectives – inflation and maximum employment – the data warrant to start hiking interest rates in March and, probably, to move swiftly thereafter. In doing so, it will be “led by the incoming data and the evolving outlook”. This data-dependency reflects a concern of tightening too much and makes monetary policy harder to predict. The faster the Fed tightens, the higher the likelihood of having it take a pause to see how the economy reacts.
The latest US economic data can be viewed in two ways. The optimistic approach would be to welcome strong Q4 2021 growth (6.7% annualised) and the fact that the economy is now almost no remaining Covid after-effects, since output has already moved back to its pre-pandemic trajectory. The second and more cautious approach would be to point out that investment has moved sideways and that growth would have been much weaker (1.6% annualised) without the exceptional contribution of inventories.
For emerging economies, the balance prospects/risks has been deteriorating since end-2021. For 2022, a bigger than expected growth slowdown is very likely, sometimes with social instability as already seen in Kazakhstan. Over the last three months, Turkey has experienced a mini financial crisis again. Monetary and exchange rate policy is betting on exports and investment to support growth and rebuild the major economic balances over the medium term, albeit at the price of short-term financial instability. This is a daring gamble that could force the authorities to introduce genuine foreign exchange controls instead of the incentive measures they have implemented so far.
For the first time since May 2019, 10-year Bund yields have moved back in positive territory. Three factors explain this development. Firstly, the traditional international spillover effect of developments in the US Treasury market where following a more hawkish tone from the Federal Reserve, yields have been on a rising trend since early December 2021. Secondly, markets are pricing the end of PEPP and the tapering of net asset purchases by the ECB. Finally, there is the prospect that, at some point, the ECB will raise its policy rate. Bond markets in the US and Germany have become highly correlated since 2021. This is an important factor given the imminent start of a rate hike cycle in the US and its possible influence on Treasury yields and, by extension, yields in the euro area.
Chinese economic growth slowed to 4% year-on-year in Q4 2021 from 4.9% in Q3. In the industrial sector, the situation improved slightly in Q4 after a summer that was badly disrupted by power cuts and supply-chain problems. Industrial growth accelerated from 3.1% y/y in September to 4.3% in December, driven by the still strong performance of exports (up 22.9% y/y in Q4). In the immediate future, however, manufacturing output and exports are likely to suffer from repercussions arising from the latest wave of the pandemic.
