Home Interest rate The world’s central banks are tightening monetary policy “in sync”, and we are entering uncharted waters

The world’s central banks are tightening monetary policy “in sync”, and we are entering uncharted waters


Throughout history, central banks have often moved in similar directions.

But the current sharpness and near-uniform global crunch is arguably unprecedented in recent decades.

U.S. hikes offset RBA increases

The simultaneous rate hikes explain why the Australian dollar remains relatively weak at around US70¢, despite rising local interest rates and record terms of trade (export prices relative to import prices ).

RBA rate hikes are being offset by larger rate hikes in the US, limiting capital flows to Australia in search of interest rate returns.

For a commodity-exporting and trade-exposed economy, the exchange rate is usually one of the main channels for transmitting monetary policy in the economy.

But the relatively weak Australian dollar means higher imported inflation and increased foreign demand for our products, contributing to domestic price pressures.

Therefore, the RBA cannot be too far behind other central banks in raising rates.

JPMorgan economists calculate that central banks in developed markets have raised policy rates by nearly 2 percentage points from the 2021 low on a GDP-weighted average measure, and are set to raise rates in the coming months.

Emerging markets – excluding China, Russia and Turkey – gained an average of 3.5 percentage points.

Not only are short-term interest rates rising, but central banks are also embarking on so-called quantitative tightening by passively allowing securities off their balance sheets or actively selling bonds.

The world has never experienced a significant global quantitative easing before. Previously, when the Fed temporarily reduced its holdings of securities in 2017 and 2018, Europe and Japan expanded their balance sheets.

Central bank balance sheets in developed markets have peaked at nearly $30 trillion thanks to their purchases of bonds and other securities during the pandemic. JPMorgan economist Ben Jarman said the stock of global central bank balance sheets is only peaking and will gradually decline, while the flow of new bond purchases is declining sharply.

Uncertainty abounds

The scale and depth of the concerted tightening is an additional source of risk and uncertainty for central bankers, investors, businesses and households around the world.

No one knows how the simultaneous rate hikes will ripple, especially for highly indebted emerging market economies that face capital outflows and exchange rate depreciations as the U.S. Fed raises interest rates.

Usually, central banks have time to pause to assess the impact of the first rate hikes, domestically and internationally, knowing that monetary policy usually takes around 12 to 18 months to have its maximum impact. But high inflation means they’ve lost that waiting option.

For the financial markets, synchronicity is a risk that has been smoldering for several years.

A veteran international bond trader said, “The pandemic has resulted in countries going through the same economic cycle and coming out of recession at the same time.

“All with significant public debt financing needs. All with cost pressures. All with expensive risky assets and high household debt. And all on the rise at the same time.

He compares it to past downturns and recoveries when there was more variance in economies and markets to offset the ups and downs in different countries.

For example, during the Asian financial crisis of 1997-98, other developed economies generally performed well.

During the 2008 GFC that plunged the United States and Europe into deep recessions and market turmoil, Asia hung on and a stimulus-fueled China held off sharply. drawn, increasing demand for Australian iron ore and coal.

“This time it’s a highly correlated recovery,” says the Observer. “Will every central bank get it right? I doubt. And they want some inflation to help pay down the public debt.

It is not surprising that central banks are evolving at the same pace.

The pandemic has been a global shock, with similar health and economic responses including lockdowns and massive stimulus payments. Policymakers underestimated the enormous power of fiscal stimulus and failed to anticipate supply constraints.

Central banks have a very narrow path to contain inflation without hurting employment too much.

Much of the inflation was initially due to supply-side shocks, which are lasting longer than expected, including transportation and logistics disruptions resulting from restrictions imposed by China, soaring energy prices and labor shortages.

The United States and Britain have lost millions of workers, perhaps due to early retirements or fears of catching the virus.

Australia missed two years of immigration, leaving a smaller pool of workers available.

Let’s hope the synchronized transatlantic economic downturn doesn’t trickle down to Australia.

Consequently, the level of supply in the economy will be permanently at a level below its pre-pandemic trajectory, even if the growth of the workforce and supply chain capacity returns to more normal rates.

Therefore, central banks cannot simply “ride through” all supply shocks. There is less supply to meet demand fueled by the stimulus, establishing a new equilibrium that interest rates must respond to.

Supply will be permanently tight relative to the pre-pandemic trajectory, so central banks need to tighten policy to cool demand from overheated consumers.

Arguably, central banks could have acted sooner, but that would not have solved the current high inflation crisis.

But an earlier tightening would have brought interest rates closer to where they should be and made it easier to reduce inflation over the next few years.

Admittedly, it is now more difficult for central banks to manage inflation.

Central banks during the post-Cold War “Great Moderation” had some chance of achieving low and stable inflation, thanks to China’s industrialization that lowered manufacturing costs and added hundreds of millions of workers to the global labor pool, globalization, free trade flows and the technological revolution.

Arguably, monetary policy has received too much praise, while other important factors have increased the economy’s supply capacity.

Today, central banks are facing the toxic combination of explosive demand and reduced supply, including the relocation of some critical manufacturing sectors, the energy crisis, geopolitical tensions that undermine trade and technology sharing. , and workforce dropouts.

Shallow recessions in the US and Europe are economists’ baseline forecasts.

Let’s hope the synchronized transatlantic economic downturn doesn’t trickle down to Australia.