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FRANKFURT – In their attempt to exit from ultra-easy monetary policy following a year of low inflation and massive response to the global pandemic, the Big Four of central banking are breaking apart.
As leaders of the world’s four top central banks gather later Wednesday to discuss monetary policy beyond the pandemic, the U.S. Federal Reserve and the Bank of England are steering towards tightening their stance, while the European Central Bank and the Bank of Japan are keeping the pedal on the metal.
Inflation developments will determine whether the world is up for a great divergence, or whether the ECB will have to begrudgingly follow the lead of the Anglo-Saxons and leave the Bank of Japan behind.
A rare live debate between the world’s top four central bankers — Federal Reserve Chair Jerome Powell, ECB President Christine Lagarde, Bank of Japan Governor Haruhiko Kuroda and Bank of England Governor Andrew Bailey — will close the ECB’s two-day conference on the future of monetary policy. In the near term at least, policymakers are set to confirm the future will look quite different in London and Washington than in Tokyo and Frankfurt.
Lagarde underlined the atypical nature of the crisis when she opened the conference on Tuesday, stressing the recovery is posing an extra challenge to policymakers around the globe as they plot an exit strategy. Leading the charge on lift-off is the Federal Reserve, which announced last week it will likely start trimming its monthly bond purchases as soon as November and signaled it may start raising rates in the second half of 2022. A day later, the Bank of England said the case for a rate hike appears “to have strengthened.”
Easy does it?
As the global economy starts to heal, helped by unprecedented central bank interventions centered around bond buying and zero interest rates, inflation pressures and financial stability risks have started to bubble up. This has prompted some other central banks to start withdrawing stimulus.
Earlier this month, the Bank of Norway was the first major Western European central bank to begin tightening, while South Korea’s central bank already raised interest rates in August and signaled further tightening ahead to stem rising financial stability risks. The Bank of Canada has already cut back on its bond purchases, and might raise rates next year.
For their part, some emerging market economies have also moved towards tighter policy regimes, faced with higher inflation on the back of exchange rate volatility.
But the ECB has made clear it doesn’t want to jump the gun.
In her Tuesday speech at the Sintra conference — the ECB’s equivalent to the Fed’s Jackson Hole gathering — Lagarde stressed that inflationary pressures in Europe are still expected to remain fleeting and the ECB has no plans to rush to an exit.
“The key challenge is to ensure that we do not overreact to transitory supply shocks that have no bearing on the medium term,” she said. She also repeated her point that even once pandemic-induced measures are phased out, the ECB will ensure interest rates and asset purchases remain supportive.
Lagarde has also been adamant that the ECB Governing Council’s decision to dial down monthly bond purchases under its crisis-fighting program shouldn’t be mistaken for the more radical step of “tapering.” The ECB will decide on the future of its crisis program only in December — and in any case, it has no plans to phase out bond purchases under other programs.
As such, the ECB’s decision to reduce asset purchases under the pandemic emergency purchase program (PEPP) should be seen as much less drastic than what the Federal Reserve is likely to announce in the next months, Lagarde has argued.
In Japan, by contrast, crisis measures have remained untouched altogether. Consumer inflation remains near zero as weak demand has forced companies to absorb rising prices for commodities and intermediate goods.
“Japan’s economy entails high uncertainties due to the spread of the Delta variant,” Kuroda said at the start of the week. “The Bank therefore thinks that it continues to be important to take measures in response to COVID-19 for the time being.”
The ECB and the BoJ aren’t the lone holdouts. The Swiss National Bank remains firmly committed to negative interest rates and foreign exchange market intervention. With the Swiss economy’s fate closely linked to exchange rate developments, its monetary policy is often closely tied to that of the ECB. Meanwhile, Sweden’s Riksbank said earlier this month that it expects to keep rates at zero well into 2024.
The extent to which the ECB will keep policy supportive will largely hinge on whether inflationary pressures will indeed be a blip or become more sustained. In September, the central bank already upgraded its inflation forecasts for the second time.
But the outlook in Europe still looks benign.
At another panel discussion Tuesday on the future of inflation — which included former Bank of England monetary policy committee member Charles Goodhart and the International Monetary Fund’s chief economist Gita Gopinath — experts agreed that inflation pressures in the eurozone are set to remain more muted than in the United States, which in turn will allow for loose monetary policy for longer.
Still, Goodhart cautioned that Europe’s demographic trends risk rising price pressures as the share of the working-age population shrinks — and, by extension, gains more wage bargaining power. Meanwhile, Gopinath warned that “at this juncture” upside risks to inflation are a concern “given the unique nature of his recovery, and very strong supply chain disruptions.”
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