US Federal Reserve chair Jerome Powell. — Bloomberg
IN recent months, the dynamics of global monetary policy have undergone a slight twist. Central banks, laser-focused on taming inflation for the past two years, are shifting their attention towards sustaining economic growth.
This change in focus is becoming more apparent as several major central banks have started to adjust their interest rates.
Interestingly, the policy move was less about lower inflationary pressures and more about slowing economic growth.
While investors generally welcome a lower interest rate, which should boost consumer spending and the stock market, is it time to declare victory against inflation?
The outcome of the recent Jackson Hole Economic Symposium has further solidified market expectations that the US Federal Reserve (Fed) may begin cutting rates as soon as next month.
In his speech, Fed chair Jerome Powell emphasised that while inflation remains a concern, the Fed does not “seek or welcome further cooling in labour market conditions”.
This is the clearest signal that the Fed is pivoting towards the other side of its dual-mandate; growth/maximum employment.
This shift underscores the increasing importance of maintaining economic stability, perhaps at the expense of slightly higher inflation.
Although inflation is approaching the 2% target, all inflation metrics suggest that the last mile towards the mark is the hardest.
To be clear, this dovish-tendency stance is not isolated to the Fed. Other major central banks are moving quicker towards rate cuts as growth decelerates.
The European Central Bank (ECB) initiated this shift in June, followed by the Bank of England (BoE) on Aug 1. The People’s Bank of China and Sweden’s Riksbank have also eased rates in response to economic headwinds.
Interestingly, the ECB and BoE’s rate cuts are followed through with higher inflation. The eurozone’s inflation ticked up from 2.6% in June to 2.8% in July, and the United Kingdom’s inflation rate rose to 2.2% in July versus 2% in June and May.
It is no surprise that the ECB raised its inflation forecast despite cutting rates, while the BoE’s rate cut decision was razor-thin at five-to-four votes. This author does not see further rate cuts without recession lights flashing right in the face.
However, Japan stands out as the only major central bank hiking interest rates amid the economy increasingly uncomfortable with “high” inflation, which is trending exceeding 2% since April 2022, a four-decade high.
Global markets wreaked havoc at the end of July following the Bank of Japan’s 25 basis-point tweaking of its 10-year bond in the yield curve control project.
While the interplay between interest rates and inflation has historically been central to monetary policy, the current landscape is more complex. If inflation continues to remain elevated, questions will follow about what truly drives major central banks’ policy if the guys holding the inflation and recession banners are staring at them.
The International Monetary Fund or IMF forecasts global average inflation to remain above pre-pandemic levels, with rates projected at 6.8% in 2023, 5.9% in 2024 and 3.7% in 2026. The ECB has also raised its inflation forecast, predicting that inflation will only drop below 2% by 2026.
Several factors contribute to this stubborn inflation, including elevated global oil prices and ongoing supply chain disruptions. These disruptions are exacerbated by the rising tariffs imposed by major economies on Chinese goods, a trend that has intensified in recent months.
Canada recently imposed a 100% tariff on Chinese electric vehicles or EVs, following earlier tariffs of up to 25% on Chinese steel and aluminium, mirroring actions taken by the United States and the European Union.
These protectionist measures are not limited to the West; countries like India, Australia, Japan and Brazil have also imposed high tariffs on Chinese imports.
A news report suggested that Thailand is also considering similar measures against cheap imports from China.
While former US president Donald Trump initiated the trade tensions with China, his successor has largely continued these policies. This indicates the broader strategic competition between big economies and China transcends Trump’s ideologies.
Going back to the earlier point about consumer confidence and stock market bulls? There are good reasons to pop the champagne when rates are lower, but the so-called “melt-up” could be short-lived.
If the cost of living is an issue, as it is now, lowering interest rates can immediately relieve those burdened by high financing costs.
Lower interest rates will improve disposable income and real wages, thus incentivising economic actors to spend and invest.
However, if we believe that inflation is indeed a monetary phenomenon, lowering interest rates means that output must play catch-up at a similar rate to keep prices stable.
Given that the “world’s factory” faces high tariffs, local production must fill the void to bring the overall balance to equilibrium. Can they boost production? Or should they?
The cut-to-rise outlook could be problematic for policymakers. They must be content with an elevated interest rates environment, or choose between price stability and growth, or rewrite a new mandate addressing post-pandemic/Trump-inspired realities.
It all comes down to production/output; the variable that advanced economies do not have the scale of (and match), unlike in Asia.
Firdaos Rosli is the chief economist of AmBank Group. The views expressed here are the writer’s own.
