The world’s central banks are not moving in harmony just yet, but at least the discord is beginning to fade.
The European Central Bank last week ruled out further interest-rate cuts in a sign that it is cautiously edging toward an exit from stimulus. Bank of England officials are considering gradually removing accommodation in coming years, though a move is some way off and the assessment will have to take into account the fallout from the nation’s messy election outcome. While the Japanese central bank has no intention of removing stimulus soon, it is said to be recalibrating communications to acknowledge that it is thinking about how to handle an eventual policy change.
The US Federal Reserve remains well ahead of the pack.
Illustration: Yusha
The US central bank is expected to lift interest rates for the fourth time this cycle at its meeting today and tomorrow, and is mapping out a plan for unwinding its US$4.5 trillion balance sheet, a process it is handling gingerly to avoid roiling global markets. Meantime, China has been allowing money markets to tighten as policymakers seek to squeeze leverage from parts of the financial system.
The nascent signs of policy synchronicity in the world’s largest economies come as global growth improves and despite central banks continuing to undershoot their inflation targets. Labor-market slack is drying up in many places and world output is expected to expand 3.5 percent this year, according to IMF forecasts, up from 3.1 percent last year.
“We’re in a sort of a global upswing,” Charlotte, North Carolina-based Wells Fargo Securities LLC global economist Jay Bryson said. “Given that, you probably don’t need these super-accommodative policy stances anymore.”
The shift has been gradual and often subtle, yet it marks a sea change. Largely in unison, central banks employed unprecedented, unconventional easing to force their economies back into gear after the global financial crisis spurred widespread unemployment and a decade of sub-par growth. In many nations, that involved large-scale asset purchase programs. In the eurozone and Japan, it included negative interest rates.
The Fed has been reducing accommodation on its own since December 2015. Now, others are beginning to discuss unwinding their policies, restoring a sense of togetherness.
“We’re talking about a change from a situation where the central banks were basically pedal to the metal, full throttle, as much monetary stimulus as you could conceivably do,” Washington-based Peterson Institute for International Economics senior fellow Jacob Funk Kirkegaard said. “Now, central banks in advanced economies are reacting to a recovering economy.”
As hiring hums along and central banks tiptoe toward the exit, the Fed stands to benefit. The US dollar has seen upward pressure as the Fed hikes and other monetary authorities ease, and a strong greenback means cheaper imports and lower inflation. The Fed’s preferred price index continues to undershoot its 2 percent goal.
“You don’t want it falling out of bed, but dollar depreciation would lead to higher inflation in the US,” Bryson said. “Frankly, I think the Fed wouldn’t be that unhappy to see higher inflation.”
The change is also good news for countries turning toward the exit, as it signals that business confidence is picking up, more people are working and the specter of another economic dip is fading from view.
“None of the big global central banks is looking to loosen policy,” London-based Capital Economics chief global economist Andrew Kenningham said. “What has changed is that the fear of outright deflation, or entrenched low inflation, has now faded.”
In Japan, the economy has expanded for five straight quarters, the best run of growth in a decade, and unemployment has dropped to levels last seen more than 20 years ago. While inflation remains stubbornly low, chaining the Bank of Japan to its stimulus program for the foreseeable future, some lawmakers have demanded the institution begin talking about how it might handle an eventual exit.
It is taking notice.
Officials realize it is not constructive to remain silent on the issue and are making it known that the Bank of Japan is conducting simulations internally on how an exit could play out, people with knowledge of discussions at the central bank said.
Bank of Japan Governor Haruhiko Kuroda and his board are expected to stand pat at the conclusion of the next policy meeting on Thursday and Friday.
In the eurozone, European Central Bank President Mario Draghi took a tiny step toward an eventual exit from extraordinary stimulus by saying last week that the risks to economic growth are now “broadly balanced” and another interest rate cut is no longer on the table. Bond purchases are still intended to run until at least the end of the year, but economists predict them to be tapered next year.
“The fear of being behind the curve is not the case — it’s more a fear of tightening policy too quickly,” London-based BMO Global Asset Management economist Steven Bell said. Even so, “you don’t want to wait too long if inflationary pressures are building and you want to get rates up, so when the next crisis occurs you’ve got a bit of ammunition.”
In Britain, the Bank of England on May 11 said that if growth keeps up, “then monetary policy will need to be tightened by a somewhat greater extent over the forecast period than the very gently rising path implied by the market yield curve.”
That position assumed a “smooth” exit by Britain from the EU, an outcome that might not be achieved if the Brexit negotiations become bogged down. The picture is even muddier now after British Prime Minister Theresa May’s snap election last week led to a hung parliament, where no single party has a majority.
Still, the broad thrust for advanced economies is to move away from easing — and they are not alone. When the Fed hiked interest rates in March, the People’s Bank of China followed suit hours later, though economists are skeptical that it would repeat the move if the Fed lifts rates this month.
“This is all good news,” Kirkegaard said. “We should no longer be afraid of a double dip, a recurring global crisis.”
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