Will the Hawks Grip onto Monetary Policies?
The tone and stance of Central Banks around the globe has been more or less the same with each region and all the major players. Since COVID had gripped the world and shocked global economies, the Central Regulators amended their Monetary Policy to the softest possible level. In other words, reducing the interest rates to all time lows and pumping capital into the economy through various programs such as quantitative easing and buying mortgage backed securities in order to ensure the banking system and economy does not again slip back into crisis.
Now the overall picture is starting to change around the world, economies are reopening, tourism has commenced and employment is generally improving. Due to this, we have started to see higher levels of inflation and economic growth across different countries such as the US, China, Europe, Australia and many other countries. Due to the high levels of inflation and improved economic outlook, many investors have asked when the Central Banks are likely to amend the Monetary Policy in order to be in line with the economic statistics we are witnessing.
The Hawk in the financial markets symbolises a stronger policy and the question is, when are we likely to see the banks change their tone. We witnessed today in New Zealand how just a change in the tone of the Reserve Bank managed to push the exchange rate of the currency higher by over 1.20% in just a few hours. The bank’s monetary policy parameters remained unchanged this morning, in line with analysts’ and investors’ expectations. The rate remained at 0.25%, while bond purchases remained at $100 billion. However, the main positive came to the market after the accompanying statement of the head of the regulator, Adrian Orr. The official said that the department is considering the possibility of starting a policy of raising rates as early as next year and at the same time, lowering the bond purchasing multitude. The inflation rate reached 2.6%, which is fully in line with the bank’s target expectations, and export prices for raw materials have increased significantly, which means that economic incentives are working effectively.
Here, we can see a good example of how a central bank has, for the first time, changed its tone from dovish to hawkish. However, this is not yet the stance of all the central banks standing behind the biggest central global banks. For example, many banks around the world have similarly advised of a higher inflation rate in the shorter term, but are yet unaware of whether the inflation rate will continue in the longer term. For example in the UK, the inflation rate jumped to 1.5% in April from 0.7% in March, due to a mix of higher oil prices, rises in regulated household energy bills, and comparisons against weak prices a year ago during the depths of the pandemic. However, the Central Bank has advised there is not yet any certain proof that the inflation rate will reach and remain at unhealthy levels, and for this reason are not yet willing to pinpoint a time for altering their monetary policy.
Something similar is being seen with the European Central Bank, which again has seen slightly higher inflation rates but is not yet willing to consider a more hawkish stance. The fact is that monetary policy cannot be positioned at such a dovish level in the longer term, which is something that all economists agree with, but the question remains as to when the trigger will be pulled as it was today with the Reserve Bank of New Zealand. Interest rates are the increased supply of a currency used by the Central Bank as a way to induce economic growth as well as healthy employment. However, keeping the monetary policy continuously in stimulus mode can become harmful in the longer run as it is known to cause a, “boom and bust” scenario.
For this reason, the market is likely to be evaluating both the employment and inflation statistics in order to determine when the central banks may follow the steps of New Zealand. The unemployment rate in the US has been recovering at healthy speeds so far this year, but had halted in the month of April. The market is likely to evaluate in detail the next scheduled employment announcement which is due to be released on the 4th June 2021. The announcement may build confidence amongst the market, or possibly do the exact opposite.