Cracks start to emerge in global central bank's four-year synchronicity

By Malcolm Scott, Jana Randow and Enda Curran

The four-year synchronization among developed-world central banks might be about to weaken as domestic drivers take over from global trends in determining price outlooks. 
 

A pioneer of inflation targeting in the early 1990s, New Zealand has a knack of setting trends in monetary policy. And it may do so again by snapping the policy uniformity, with traders pricing the possibility of an interest-rate hike that ANZ Bank economists say could come as soon as Feb 28.

There’s potential for the convergence trend to crack elsewhere too. In the US, proof that inflation remains sticky and the labor market sound has convinced traders to embrace the Federal Reserve’s push-back against market bets on near-term easing. 

In the euro area, which avoided a recession last year only by the slimmest of margins, price pressures are retreating faster than expected, backing arguments of those pushing for earlier cuts. 

Traders are piling into bets the Swiss National Bank will cut interest rates as early as next month. And the UK is still suffering from the worst of both worlds, a downturn in the economy and high inflation, probably leaving the Bank of England in the toughest spot. 

The International Monetary Fund’s latest round of forecasts highlights the divergence: an improved US outlook, worse prospects for the euro zone and miserable figures for the UK.

JPMorgan strategists advise clients to play the US-Europe growth divide by preferring US equities, credit and the dollar as well as bunds, according to a note dated Feb. 12. They also expect both the Bank of Canada and Reserve Bank of Australia to remain more hawkish than global peers. 

Underscoring the different policy path, RBA Governor Michele Bullock wrong-footed markets anticipating a dovish tone at the board’s first meeting of the year on Feb. 6, saying “a further increase in interest rates cannot be ruled out.”

Meantime Japan, long an outlier in its multi-decade quest to defeat deflation, may diverge the other way with its first interest-rate hike since 2007 in coming months.

A year from now, bond traders expect benchmark rates will be about 100 basis points lower in the US, around 120 points lower in Europe but just 40 points below today’s level in Australia and roughly 30 points higher in Japan. 

U-Turn Fears
 

Strategists at Citigroup Inc. say traders need to hedge the risk of a very brief Fed easing cycle followed by rate increases shortly thereafter.

That’s a scenario European Central Bank officials are trying to avoid, concerned that a quick U-turn could be seen as them underestimating inflation all over again. 

Policymakers have spent much time discussing the risks of acting too soon and being surprised by resurgent price pressures or waiting longer and potentially damping demand too much — with the latter position currently garnering more support.

IMF Chief Economist Pierre-Olivier Gourinchas says central banks should avoid premature easing that would undo hard-earned credibility gains and lead to a rebound in inflation, but also not delay cuts too much, jeopardizing growth and risking inflation falling below target.

“My sense is that the US, where inflation appears more demand-driven, needs to focus on risks in the first category, while the euro area, where the surge in energy prices has played a disproportionate role, needs to manage more the second risk,” he wrote in a recent note. “In both cases, staying on the path toward a soft landing may not be easy.”

Minutes of the Fed and ECB’s January meetings to be released on Wednesday and Thursday will be scrutinized for the latest insights on policy direction and pace.  

Local Pressures
 

A shift in inflation drivers is making an accurate analysis of existing trends complicated for all. Price pressures are increasingly driven by services, with wages having a larger impact than in manufacturing.

Such local pressures are by definition more idiosyncratic, meaning central banks will need to react to them in their own ways. In the January US inflation report, for instance, gains were fueled by increases in the prices for food, car insurance and medical care, while shelter costs contributed to more than two-thirds of the overall increase.

In New Zealand’s case, fourth-quarter underlying inflation was higher than policymakers expected even as slowing tradables prices helped the headline consumer price index level to moderate. Eight of the 11 main groups in the CPI basket increased in the quarter, led by rents, residential construction costs and local government land taxes.

What Bloomberg Economics Says...
 

“Easing inflation and cooling growth has fostered expectations that monetary policymakers will pivot and ease policy this year. While there was solidarity on the fight against inflation, outliers are inevitable as the tide turns. Individual countries’ circumstances will play a bigger role in shifting to rate cuts, at least initially. In New Zealand’s case the RBNZ’s focus on the potential inflationary impulse from currently-high migration is fueling the risk that rates may be higher for a little while yet.”

— James McIntyre, economist

Varying Neutral
 

A shift to more varied central-bank policies would be a return to the norm outside of crisis periods. 

But even then, broad trends in technology, energy and commodities that affect all economies will likely keep some degree of consistency in policy direction. Foreign exchange dynamics — where those with relatively higher policy rates would expect currency appreciation, eventually damping price pressures — also suggest some herd behavior will endure.  

Longer term though, central banks from Europe, North America and the South Pacific must all contend with very different structural issues such as varying population growth rates, energy import dependence, supply-chain shifts and housing dynamics. And that makes it almost inevitable that the uniformity seen since mid 2020 will ebb.

“Central banks will be lowering rates at different speeds,” said Mickey Levy, a visiting scholar at the Hoover Institution. “While inflation has declined most everywhere, central bankers face different inflation and economic conditions that determine the appropriate policy rate needed to achieve their objectives.”