The world’s top central banks are diverging, as some turn to tackling surging inflation while others keep stoking demand, a split that looks set to widen in 2022.
The differences will be on full display this week with the final decisions for 2021 due at the US Federal Reserve, European Central Bank, Bank of Japan and Bank of England, which are together responsible for monetary policy in almost half of the world economy. They won’t be alone - about 16 counterparts also meet this week, including those in Switzerland, Norway, Mexico and Russia.
The latest wild-card is the omicron coronavirus variant - how severe its impact proves to be on growth and inflation will be a crucial consideration for officials into the new year. The worry is that a strain more resistant to vaccines would force governments to impose new restrictions on business and keep consumers at home.
A shift in policy always carries risks. Tightening and then discovering the inflation threat was temporary all along - as many central bankers have said all along - could derail recoveries; waiting and finding that price pressures are persistent could require more aggressive tightening than otherwise.
“The likelihood of policy slip-ups is now much much greater,” said Freya Beamish, head of macro research at TS Lombard. The inflation outlook is confused by “the presence of an endemic virus,” she said.
Fed chair Jerome Powell is tipped to confirm on Wednesday that he’ll deliver a quicker withdrawal of stimulus than planned just a month ago. He may even hint at being open to raising interest rates sooner than expected in 2022 if inflation persists near its highest in four decades.
The outlook for his central banking peers is less clear, marking an end of two years in which they largely synchronised their efforts to tackle the coronavirus recession, only to find inflation surging back stronger than anticipated in many key economies.
Although she’s likely to end emergency stimulus, ECB President Christine Lagarde will stick to an expansionary policy stance on Thursday as she insists soaring prices are due to factors that won’t endure, such as energy costs, supply snags and statistical quirks. Lagarde has indicated she doesn’t expect to raise rates in 2023.
Subdued price pressures in Japan are also allowing BOJ Governor Haruhiko Kuroda to hold onto a doggedly dovish stance, even as the government rolls out another round of record spending. Japanese policy makers convene on Friday.
Perhaps most strikingly, governor Andrew Bailey’s Bank of England is now cooling on the need to hike rates, having not long ago flirted with a shift. In contrast, Norway’s central bank may hike again.
Elsewhere, while the People’s Bank of China has started to ease policy as a property-market downturn threatens to hamper growth, other emerging economies such as Brazil and Russia are aggressively tightening.
Russia may do so again this week, as may Mexico, Chile, Colombia and Hungary. Still, Turkey is set to cut again.
“We are set for increasing monetary policy divergence,” said Alicia Garcia Herrero, chief economist for Asia Pacific at Natixis SA.
Even if the path of rates differs, a wide-scale slowing of bond-buying programs will reduce support for economies. BofA Global Research strategists predict liquidity will peak in the first quarter of 2022, and that the Fed, ECB and BOE are on course to shrink their balance sheets to $18 trillion by the end of next year from above $20tn at the start of the year.
The implications for divisions in global policy could also include a rising dollar against a weakening euro and yuan, potentially stoking currency tensions as China’s exports get another lift. A stronger greenback would also lure money away from emerging markets, undermining their own fragile recoveries.
“The increase in the Fed fund rates next year and a stronger US dollar will be a testing time for emerging markets,” said Jerome Jean Haegeli, chief economist at Swiss Re AG in Zurich, and previously of the International Monetary Fund. “The fault lines opened up by Covid-19 are looking more persistent.”
At the Fed, a widely-anticipated decision to wind up its bond-buying more quickly could leave it in a position to raise rates as early as March, should it deem that necessary to stem surging inflation.
US consumer prices rose the fastest in almost four decades, government data showed on Friday.
Fed watchers expect the central bank’s new economic forecasts to show for the first time that a majority of policy makers project at least one rate increase in 2022.
In the UK, traders convinced of a liftoff this year pared bets after the emergence of omicron, and they’ll likely be proved right if comments from the BOE’s most hawkish official serve as a guide. Michael Saunders recently highlighted the benefits of waiting before raising rates from 0.1% to assess the economic impact of the variant.
The UK’s tight labour market is nevertheless driving up wage growth, and officials are concerned that high inflation, expected to hit a decade high of 5% next year, is seeping into expectations. Unlike the Fed, the BOE’s mandate keeps it focused on prices.
At the ECB, Lagarde is also sticking to the narrative that record-high inflation will eventually subside - even though officials acknowledge that persistent supply bottlenecks mean it may take longer than initially thought, and some policy makers are getting uncomfortable just standing by.
With the European economy close to pre-crisis levels, the institution is set to confirm that bond-buying under its signature €1.85tn ($2.1tn) pandemic program will end in March as planned. Regular asset purchases will continue. Rate hikes, economists surveyed by Bloomberg agree, won’t be on the agenda until 2023.
Ultimately, the severity of omicron will play a huge role in the monetary policy story next year. Two weeks after the variant’s discovery, there are plenty of unknowns.
“If the variant dampens demand more than it exacerbates supply-chain disruptions, it could prove disinflationary,” said economist Sian Fenner of Oxford Economics. “But the reverse is equally true.”
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