The shift under way in global monetary policy is more subtle evolution than revolution. For all the talk about a pivot toward higher interest rates, conditions are likely to remain relatively lax for years to come in the economies that matter most.
Central banks are unlikely to engage in new aggressive approaches to spurring growth and buttressing markets; the global expansion in 2021 is projected to be one of the strongest in decades after the worst showing in almost a century last year. That isn't the same thing as a consequential tightening. Any reversion to what constituted normal before the pandemic is years away, at a minimum. The three institutions that traditionally have dominated the policy landscape — the Federal Reserve, European Central Bank and Bank of Japan — are going nowhere particularly fast. Even China, which didn't do as much in the teeth of recession, is proceeding cautiously.
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The tightening narrative rests, in part, on some complicated examples. Turkey is often cited because policy makers sound hawkish after massive rate increases last year, which aimed to stem a collapse in the currency and contain truly high inflation. Turkey ended 2020 with the steepest borrowing costs in the Group of 20, and its leadership ranks have been purged. These extreme events make the country more of an outlier than anything. New Zealand has also been on investors’ minds since last month, when officials penciled in hikes for 2022. Those forecasts have been brought forward by investors. Yet the Reserve Bank of New Zealand laid out a lot of caveats. “You are talking about the second half of next year,” RBNZ Governor Adrian Orr said in late May. “Who knows where we will be by then?” (If you didn’t tune into that briefing, it’s worth a listen.)
This isn't to say there's no movement on the policy front. The Reserve Bank of Australia may begin retiring one of its emergency programs next week, an effort to keep yields on three notes close to zero. At the same time, the RBA is expected to continue its quantitative easing and Governor Philip Lowe has said repeatedly a nudge higher in the benchmark rate is probably years away. South Korea, enjoying a robust recovery thanks to technology exports, may increase rates by year-end. Important? Absolutely. Bank of Korea Governor Lee Ju-yeol nevertheless emphasized last week that with the main rate at a record low of 0.5%, one or two steps away from an emergency level of accommodation shouldn’t be seen as a tightening. Canada has begun tapering its asset purchases.
The issues Australia and South Korea wrestle with encapsulating a broader dilemma. Policy makers need to acknowledge that economies are returning to health, financial markets have broadly stabilized and inflation is picking up. Continuing without any sort of adjustment, however nuanced and gradual, isn't credible. They also say that the rise in inflation is unlikely to be prolonged and that labor markets aren’t fully healed. It's a delicate balance for the most deft of central bankers. The good news for Sydney and Seoul is that the fate of the world doesn't sit squarely on their shoulders.
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That responsibility falls to the Federal Reserve. Though some investors were startled that the Federal Open Market Committee projected two rate increases in 2023, senior officials have stressed their belief inflation will remain under control and jumps in prices won’t be sustained. The Fed is yet to unveil a timeline for retreating from asset purchases. A higher federal funds rate is something for the very long-term horizon. (I wouldn’t pay a lot of attention to the handful of Fed district bank presidents laying out scenarios in which rates rise next year. More important is that the top brass remains dovish.)
The People’s Bank of China, often portrayed as being a step ahead of its American counterpart, is proceeding cautiously. Beijing is reining in stimulus but is mindful not to overdo it, in part for fear of greater capital inflows that would strengthen the yuan. After a muscular recovery from a slump early in 2020, China's economy may also be starting to slow, or at least consolidate. And while factory-gate prices have galloped ahead, consumer inflation remains muted. China, which didn't ease as aggressively as the Fed in the first place, is unlikely to become overtly more hawkish.
The monetary gymnastics of early 2020 were never going to last forever. But the easy money isn’t over, either. Don't conflate action at the sidelines with the main event.