Global Economy: Hawkish doves

Evidence continues to mount that the era of extraordinary central bank policy accommodation is at an end. This comes as a growing number of monetary policymakers consider following the US Federal Reserve’s (FED) lead to ‘normalise’ policy settings. However, there remains considerable disparity between the so-called hawks and doves – or perhaps more accurately, the hawkish-doves and the more cautious policymakers.

Prominent amongst the former are the Fed who are already raising rates and now also the Bank of Canada (BoC) who have taken the first tentative step. Then there is the Bank of England (BoE), which remains the most hawkish bank yet to raise rates, while definitely considering doing so. The more dovish set are those that now see significantly diminished risks of further policy easing and are at least considering a potentially tighter stance in future. This group consists of the European Central Bank (ECB), Norges Bank, and Reserve Bank of New Zealand (RBNZ). The Reserve Bank of Australia (RBA) also seems, at this stage at least, to be content to be in this group. It has adopted a “glass half full” narrative with regard to the economy, but sees no justification to warrant a shift in tone. And lastly the Bank of Japan, which is broadly expected to stay on its accommodative course.

Assisting central banks in this policy shift is arguably a somewhat softer view of their key policy mandate – that is inflation targeting. Very few central banks are hitting formal targets and inflation outlooks are not at all certain. Instead, there is seemingly more attention being placed on managing the cycle. At this point, if growth is solid enough for the output gap to be narrowing and unemployment to drift towards full employment, then this is an environment that warrants an adjustment of ultra-accommodative policy. The expectation of accelerating inflation towards central bank targets, with limited threat of deflation, is seemingly now enough to at least consider withdrawing some policy stimulus.

Current cyclical dynamics aside, in which the Phillips curve is either broken or shifted lower, there are also the medium to long-term disinflationary impacts of technological advances and automation to consider. This may see global central banks becoming accustomed and attuned to inflation hovering around the lower ranges of their respective target bands – or in time could even see them consider lowering their targets outright.

A further concern is financial stability and the future risks that household debt accumulation may present. These risks are only exacerbated by having interest rates too low for too long – a mistake that has arguably been made before in the US.

Global: Inflation rates
Most central banks have inflation below target


Source: IFM Investors, Various central banks, Bloomberg
*Midpoint of +/1.0% band

It should also be noted that this coincidental rather than coordinated shift in monetary policy merely represents steps towards a gradual removal of what are ultraaccommodative policy settings. It in no way represents moving convincingly towards settings that would be considered as contractionary policy, and slightly tighter policy settings are therefore unlikely to materially curb the gradual acceleration of inflation.

We would also assert that with potential growth rates in most developed economies lower now than before the global financial crisis, central banks will be feeling their way to what are clearly lower neutral policy rates for an extended period of time. This mix of lower neutral policy rates, lower inflation and lower potential growth rates all support the notion that bond yields, rising gradually, will remain lower for longer. Consequently, the reflation thematic, although intact, will only gradually gather momentum.