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Is this the week when the world as we’ve known it since the onset of the pandemic, or at least its financial settings, starts to change? With three major central banks meeting this week, including the Reserve Bank, that’s a distinct possibility.
The Reserve Bank meeting on Melbourne Cup day will kick off a week in which the US Federal Reserve and Bank of England will also make decisions that could reshape the global monetary policy landscape.
Markets will have all eyes on the Fed this week. Credit:AP
The RBA and the Fed will have to consider whether to exit from the aggressive policies they introduced in March last as the destructive impact of the pandemic first became clear and the Bank of England may start to raise UK interest rates even as it continues to buy bonds under its quantitative easing program.
The global significance of the Fed’s policies means that its meeting, at which it is expected to announce a schedule for the “tapering” of its $US120 billion ($160 billion) a month of bond and mortgage purchases, could have the most impact on financial markets.
The RBA’s meeting on Tuesday will be closely watched around the world, however, not only because it will be the first of the key meetings – the Fed meeting starts Wednesday and the Bank of England’s Thursday – but because the bank, highly regarded by its peers, will have its credibility tested by the outcome.
All the major central banks are under pressure because of the surge in global inflation this year amid continuing severe supply chain disruptions and soaring energy prices. The oil price was trading below $US60 a barrel before the pandemic; having traded down below $US20 a barrel now above $US80 a barrel. Gas and energy coal prices have risen even more.
In some economies the sustained rise in inflation rates to their highest levels in decades is also being accompanied by something completely unexpected.
Even as economic growth rates surge in the major economies – the US and Chinese economies are now larger than they were pre-pandemic and Europe’s is only 0.5 per cent smaller – wage costs are spiking amid labour shortages.
In the period between the 2008 global financial crisis and the pandemic central banks were desperate to kindle some inflation in a low-inflation, low-growth environment. The pandemic inspired unprecedented actions to protect economies from the worst effects of the lockdowns and other disruptions it generated. Those measures may have resolved the low-inflation impasse.
The Fed launched its quantitative easing program in March last year, buying $US80 billion a month of bonds and $US40 billion of mortgage securities. The Fed’s balance sheet has swollen from less than $US4 trillion to more than $US8.5 trillion during the pandemic.
The RBA has bought more than $250 billion of bonds, initially buying $5 billion a week and more recently $4 billion, as part of a broader response to COVID-19 that included providing ultra-cheap funding to banks.
The RBA’s meeting on Tuesday will be closely watched around the world, however, not only because it will be the first of the key meetings – the Fed meeting starts Wednesday and the Bank of England’s Thursday – but because the bank, highly regarded by its peers, will have its credibility tested by the outcome.Credit:Louie Douvis
The bond-buying was designed to keep the three-year bond rate at or below the cash rate of 0.10 per cent, with the RBA committing to maintaining that targeted yield until 2024.
The program worked well, until last week’s inflation data showed the core inflation rate had kicked up and is now in the RBA’s targeted range of two to three per cent for the first time in six years.
The key April 2024 bond yield spiked to almost 0.8 per cent, with no signs that the RBA was in the market trying to keep it close to its 0.1 per cent target.
That lack of RBA action has led to economists expecting the RBA to abandon the yield target to focus on the inflation rate, even if a policy U-turn of that magnitude might damage its credibility.
It could be damned if it does. Central banks need financial markets to believe they will honour their commitments.
It might also be damned if it doesn’t. If it keeps rates at negligible levels and the inflation rate keeps surging it could subsequently be forced into draconian, economy-damaging, measures.
The RBA shares the basic central bank dilemma of whether and how to respond to the elevated levels of inflation with the other central banks. Other banks – notably the Bank of Canada last week – have ended their extraordinary measures in response to the pandemic and begun raising their policy rates.
This week’s meetings will provide an update of the RBA and Fed’s view of the state of their economies, along with any foreshadowing of shifts in their monetary policies. For markets, it is the Fed that matters.
Still others, like the European Central Bank are reluctant to respond to what might still be a transitory surge inflation generated by supply chain issues that might soon be resolved (although that appears unlikely).
The ECB has only marginally reduced the scale of its bond-buying even though inflation in Germany has hit 4.6 per cent and, in Spain, 5.5 per cent. Across the eurozone the inflation rate is 4.1 per cent, a level not seen since the financial crisis.
US GDP growth is running at about 5 per cent, its strongest rate since the early 1980s. The eurozone growth rate in the September quarter was two per cent and 13.7 per cent higher than the quarter last year.
China, hit hard by the supply chain issues and rocketing energy costs (and some internal problems, like its property development crisis) came out of the pandemic first and fastest but has recently slowed markedly.
Fed chairman Jerome Powell. The Fed has indicated there might be a rate increase late next year but anything more than that could greatly unsettle markets – shares, bonds and property – that have been addicted to low rates and overdoses of central bank liquidity since the financial crisis.Credit:AP
The recent lengthy lockdowns in Victoria and NSW will obviously have a damaging impact on Australia’s GDP but, with the two key states now largely open for business, it could rebound quite quickly.
This week’s meetings will provide an update of the RBA and Fed’s view of the state of their economies, along with any foreshadowing of shifts in their monetary policies.
For markets, it is the Fed that matters.
An announcement of a tapering of the Fed’s asset purchases has been expected for some time and seems to be factored into the US bond market, although a faster-than-expected winding back of the program – the market expects the Fed to make its last purchase by the middle of next year – might cause some ructions.
Any suggestion that US interest rates will begin rising next year might have more pronounced effects.
The Fed has indicated there might be a rate increase late next year but anything more than that could greatly unsettle markets – shares, bonds and property – that have been addicted to low rates and overdoses of central bank liquidity since the financial crisis.
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