It was a rare coincidence that last week, four major central banks – the Federal Reserve, the ECB, the Bank of England and the Bank of Japan – held their monetary policy meeting. Considering that they all target 2% inflation, their decisions shed light on the role of differences in terms of approach as well as in the economic environment and outlook. However, they share a preparedness to react when circumstances require. Given the mounting concern about the Omicron variant, more than ever, monetary policy is data-dependent.
After last year’s sudden, deep and a-typical recession, caused by the Covid-19 pandemic, this year has also been a-typical in several respects. Supply bottlenecks and supply disruption have been dominant themes throughout the year, acting as a headwind to growth, both directly but also indirectly, by causing a pick-up in inflation to levels not seen in decades. Under the assumption that the pandemic is gradually becoming less of an issue thanks to the vaccination levels, 2022 should see a normalisation in terms of growth, inflation and monetary policy.
With the inflationary surge in the US showing no signs of stopping, the Federal Reserve is no longer taking a accommodative stance and could accelerate the tapering of quantitative easing. Inflation has also spread to asset prices: real estate and stock prices have climbed to peak levels. Unless the emergence of the Omicron variant radically changes the situation, everything points to a key rate hike in 2022, possibly as early as next summer.
To raise or not to raise interest rates? That is the question facing the Bank of England as inflation accelerates and the number of Covid-19 cases surges again, this time with Omicron, the new Covid-19 “variant of concern”. After rebounding strongly through summer 2021, economic growth has also lost the support of public spending, and is showing a few signs of levelling off.
The recovery in emerging economies since mid-2020 has been accompanied by a tightening of monetary policy in Latin America and Europe but not in Asia so far (except South Korea). The main reasons for this lie in the level and dynamics of inflation. Inflation is strong and accelerating in Latin America and Europe, more modest and still contained in Asia
In most European countries, the structural primary deficit should shrink next year. This reduction represents a negative fiscal impulse, raising concern that it would act as a headwind to growth. However, the level of the primary deficit is such that it still corresponds to an accommodative fiscal stance. Taking into account national fiscal policies as well as expenditures financed by the Recovery and Resilience Facility and other EU grants, fiscal policy in the euro area should have a significant positive impact on GDP growth next year, thereby accompanying and strengthening the ongoing recovery. In addition, it should enhance the effectiveness of the ECB’s accommodative policy.
The ECB’s meeting on 16 December is highly anticipated, primarily for the central bank’s new growth and inflation forecasts. When it comes to growth, the ECB’s September forecast was for annual average growth of 5% in 2021, 4.6% in 2022 and 2.1% in 2023. It could leave its 2021 forecast unchanged, with the positive figures for Q3 offset by a less positive view of Q4, due to the effect of supply constraints, inflationary pressures and a resurgence of the pandemic. Growth in 2022 will be weakened by the same factors. The scale of the forecast downward revision will indicate the level of the ECB’s concerns. It will also be interesting to see whether any growth ‘lost’ in 2022 will be shifted, in part at least, into a higher forecast for 2023.
In his testimony to a commission of the US Senate, Jerome Powell has acknowledged that inflation is less transitory than considered hitherto, adding that, as a consequence, a faster tapering seems warranted. Despite this hawkish tone, the reaction of US Treasuries was muted. This may, amongst other things, reflect concern about how the pandemic might evolve. The new Omicron variant undeniably represents an uncertainty shock for households and companies. It comes on top of a negative supply shock that is already a clear headwind to demand. It clearly makes the task of central banks more complicated than ever when deciding how much of a monetary headwind they can create.
Last July, the US Federal Reserve (Fed) expanded its scope of intervention in the money markets. It now has a permanent repo facility (Standing Repo Facility or SRF) in addition to its reverse repo facility (Reverse Repo Program or RRP). These tools should allow the Fed to modulate its supply of central bank money, downwards as well as upwards, in periods of pressure on short-term market rates. In the current context of abundant central bank liquidity and limited supply of government securities, money market funds have made considerable use of the RRP. The ability of the SRF to reduce tension in the event of a drying up of central bank liquidity could, however, be countered by various factors such as the leverage constraints to which primary dealers and banks are subject.
Over the past 15 days, the Turkish lira has depreciated 21% against the euro, including a single-day decline of more than 10% on 23 November. At the same time, 10-year government bond yields have risen above the 20% threshold. This bout of weakness was triggered by 1) another cut in the central bank’s key rate on 19 November, from 16% to 15%, despite surging inflation, which reached 19.9% year-on-year in October, and 2) President Erdogan’s statements justifying the easing of monetary policy as part of a new economic policy, after the President demanded that the National Security Council declare an “economic war of independence”. The President also lashed out at the opportunistic speculative behaviour that took advantage of the lira’s depreciation to raise prices
The ECB insists on the need for patience before considering a policy tightening, despite current elevated levels of inflation. It believes that inflation will decline next year and that a wage-price spiral is unlikely to develop. Moreover, inflation expectations remain well anchored. Demand in the euro area is suffering from the headwind created by the jump in energy prices. Reacting to this type of inflation by tightening monetary policy would create the risk of reducing demand even more. To avoid such an outcome, it makes sense for the central bank to wait for more information to arrive, thereby adopting a risk management approach of monetary policy
Markets have been pricing in an early lift-off of the ECB’s deposit rate. The ECB argues that, considering its inflation outlook, this is not warranted. This difference in view could reflect a loss of central bank credibility. More likely is that market participants and the ECB disagree on the inflation outlook. Another explanation is that investors focus on the distribution of possible inflation outcomes and are concerned about the risks of inflation surprising to the upside.
Successful market timing between equities and cash requires high skill levels. Very low official interest rates, through their impact on market rates, create a disincentive for doing market timing because they increase the break-even skill level. The same applies for quantitative easing. These considerations are important from a financial stability perspective. Growing investor reluctance to do market timing will probably lead to a decline in equity market volatility and an increase in equity valuations. The former provides a false sense of safety whereas the latter increases the sensitivity to negative news and hence increases the riskiness.
Monetary desynchronisation between the US and the Eurozone seems unavoidable due to a very different performance in terms of inflation. Whether this will complicate the ECB’s task of reaching its inflation target depends, in the short run, on the impact on financial conditions in the euro area. This influence will probably be small. In the medium run, when the US tightening cycle is well underway, US domestic demand growth will be slowing down, which will weigh on imports and hence Eurozone exports to the US. This would complicate matters for the ECB if by then, inflation has not yet reached its target.
The new macroeconomic projections of the ECB staff provide sobering reading for savers hoping that, one day, the policy rate will be raised. It is clear that at the current juncture, certain conditions of the recently updated forward guidance on interest rates states are not met. Based on the latest ECB projections, it seems this would still be the case in 2023, even under the hypothesis of a mild scenario. The slow increase of underlying inflation would probably be considered as unsatisfactory. Savers can only hope that the interaction between growth and inflation will evolve or that the ECB projections turn out to be too cautious.
In the early phase of QE, financial markets perceive central bank forward guidance on asset purchases and on policy rates to be closely linked. This generates a mutual reinforcement of both instruments. At a later stage, there may be mounting concern that the signalling works in the other direction as well. Scaling back asset purchases could be interpreted as a signal that a rate hike will follow soon once the net purchases have ended. In the US, Jerome Powell has been very clear that tapering would not signal a change in the outlook for the federal funds rate. In the Eurozone, both types of guidance are explicitly linked. This may complicate the scaling back of asset purchases in view of the impact on rate expectations
On 28 July, the US Federal Reserve (Fed) announced that it would establish a Standing Repo Facility (SRF). Each eligible counterparty* will now be able to borrow, every business day and on an overnight basis, up to USD 120 billion of central-bank liquidity as part of the SRF**. Operations will bear interest at the marginal lending facility rate (25bp) and be capped at USD 500 billion.The SRF gives the Fed a new tool for detecting possible central-bank money shortages. In September 2019, the system was introduced on an emergency basis and temporarily, and helped to ease the repo markets crisis
The outcome of the ECB’s strategy review shows that the governing council has carefully listened to what its audience had to say. Its inflation objective is now truly symmetric, which addresses the perception that its previous objective was asymmetric. Three other changes reflect points that were strongly emphasized during the outreach events organised by the Eurosystem. The cost of owner-occupied housing will be taken into account when assessing the inflation environment. The communication will become geared towards a broader public and a decision has been taken to commit to an ambitious climate-related action plan. Now it’s back to the hard work of trying to push inflation up to 2%.
The very accommodative policies implemented by the Federal Council and the Swiss National Bank have been very successful in limiting the economic consequences of the pandemic. In 2020, economic activity contracted by 3%. The latest business cycle indicators point to a strong rebound in the second half of the year. The recovery is broad-based. Private consumption will be one of the main engines of growth, as households will spend part of the savings accumulated during the crisis. The breakdown of the negotiations between the Swiss Confederation and the EU, and the possible introduction of a global minimum corporation tax rate are likely to undermine the country’s competitiveness in the medium term.
On 16 June, the US Federal Reserve (Fed) extended its temporary swap agreements through 31 December 2021*. This facility, which offers foreign central banks the possibility of obtaining dollars from the Fed and then lending them to local commercial banks, is not being drawn on much today, but it did help alleviate global pressures on the USD liquidity due to the Covid-19 shock. These swap agreements had already been set up during the 2008 financial crisis, albeit in a distorted manner, since they were largely used as a substitute for the discount window. In the end, most of the liquidity lent by the Fed as part of these swap agreements was lent out again to the US branches of foreign banks to counter the abrupt drying up of the USD short-term debt market
In the wake of the Covid-19 crisis, bank deposits, which represent the main component of broad money, have seen extremely rapid growth in both the eurozone and the USA. The origins of this newly created money have frequently been imperfectly identified, and the same goes for the possible factors for its destruction. The European methodology for monitoring money supply nevertheless offers a valuable basis for analysis. In this article we will apply this to US data. We learn that between them, the amplification of the Federal Reserve’s securities purchasing programme and the Treasury-guaranteed loan scheme to companies are sufficient to explain the rapid rise in the rate of growth in bank deposits
The Covid-19 pandemic has had a significant impact on the Moroccan economy. After an unprecedented 6.3% decline in GDP in 2020, the first signs of a recovery are still fragile, even though vaccination campaigns are progressing in both Morocco and Europe, by far the country’s biggest trading partner. This is mainly due to the sluggishness of the tourism industry. It is thus vital that the authorities continue to provide support this year. Despite the rise in public debt, fiscal consolidation is unlikely to start before 2022. The rating agencies S&P and Fitch have downgraded the country to speculative grade. For the moment, however, macroeconomic stability is not a major source of concern. But tight fiscal manoeuvring room could become problematic in years to come
Having been rising for several years now, non-financial company (NFC) sight deposits have been boosted to new record levels in the euro area under the influence of the health crisis and government measures to support company financing. Their outstanding amount reached EUR 2,591 bn for the euro area as a whole in March 2021 (of which 26% in France, 23% in Germany, 14% in Italy and 11% in Spain)
Given the way outstanding amounts of equity and debt are valued[1] in national financial accounts[2], debt ratios calculated using these figures can give a distorted picture of the financial structure of non-financial companies. In contrast, capital increases and self-financing give a reliable approximation of changes in company capital. Our calculations suggest that French companies went into the pandemic in a strengthened financial position. Thus, the unprecedented increase in financial debt in 2020 (EUR 206 billion, with nearly EUR 130 billion in the form of government-guaranteed loans) was preceded, between 2015 and 2018, by a marked rise in capital, as the result of a significant increase in equity issues
The November 2020 announcement that monetary policy would move in a new direction had tamed financial tensions. However, as the Central Bank Governor was removed in March 2021, uncertainty came back. Exchange rate depreciation pressures have reappeared and interest rates and risk premiums have risen. Growth support will be the top policy priority, but at the price of maintaining significant macroeconomic imbalances. Credit risk is not reflected into the non-performing loan ratio but the forbearance period which is allowing the postponement of their reporting will end at mid-2021. The observed corporate investment recovery is welcomed, as a precondition to improve potential growth, but other conditions such as productivity growth are still missing.
