From a monetary policy perspective, 2017 was a year in which central banks around the globe shifted, almost in synchronized step it seemed, to refocus on policy “normalization”, at least in some way, shape or form. As well, few surprises are expected during 2018 from any of the major central banks, as monetary authorities continue to coast, with the goal of making sure no significant ripples are generated. By and large, central banks appear content to slowly drift down the river with few, if any, adjustments to the policy path forecast for the coming year.
Indeed, when it comes to the possibility of a sudden need to pull at the wheel, the biggest 'threats' are a show of stronger-than-expected economic growth that might serve to finally push stubbornly subdued inflation back on course. What may, with hindsight, become the markets’ worst-learned lesson from 2017, central banks have made every effort to telegraph their message far ahead of time, fueling the expectation that 'passengers' can expect to be warned well in advance of any jerk at the wheel.
With that in mind, we look ahead to where the Federal Reserve, European Central Bank (ECB), Bank of England (BoE) and Bank of Japan (BoJ) are likely headed in 2018.
With the process for the removal of accommodation well underway, the changing of the guard at the helm of the Federal Reserve—with Janet Yellen passing the baton to Jerome Powell in February—may mean little for US monetary policy in 2018.
In the latest economic projections released in December, the Fed itself predicted that there would be three rate hikes in 2018 and although President Donald Trump still has spaces to fill at the US central bank, it’s looking less and less likely that there will be undo pressure from the White House.
Despite Trump’s accusations on his campaign trail in 2016 that the Fed had been artificially pumping a stock market bubble, the President has spent the first year in office repeatedly taking credit for new record highs on Wall Street, suggesting that there is little incentive for him now to shake up the Fed’s trajectory.
With policymakers insisting on a gradual, data-dependent tightening in an environment where inflation is only slowly inching up towards the 2% target, there seems to be little room for surprise.
In fact, even as the Fed has finally begun to fulfill its own promises—with the beginning of tapering of its quantitative easing program and slight nudges to interest rates—the major shift has been that policy meetings have become mostly a blip on the radar.
Rate hikes were well telegraphed in 2017, with markets fully pricing in the move far ahead of the event itself. Odder still, stocks seem to have barely noticed the policy adjustments with US equities constantly reaching new plateaus.
The changes to the Fed’s dovish outlook are still far from leaning into an even remotely “hawkish” camp. 2018 looks to be shaping up a lot like the year just past: the Fed trying to “over-communicate” to the markets what it will do far in advance.
Unless economic growth moves into overdrive, with sufficient force to start pushing wages sharply higher with their corresponding upward effect on inflation—the absence of which has confounded policymakers despite US unemployment being at nearly a 17-year low and expected to fall even further in 2018—it seems like the Fed’s path forward with policy tightening in the coming year will remain steady as she goes.
The ECB appears to be letting the Fed take the lead and then cautiously following. In its December meeting, the euro zone monetary authority confirmed its previously announced plans to cut monthly asset purchases in half to €30 billion ($36 billion) beginning in January and extend those purchases to:
“...the end of September 2018, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim”.
The ECB’s stance follows in the Fed’s footsteps in terms of being gradually “less dovish”. ECB chief Mario Draghi has insisted that interest rates will not move “for an extended period of time, and well past the horizon of our net asset purchases”. Markets, in fact, are not pricing in a move until at least 2019.
Not unlike its US counterpart, the ECB has been fighting remarkably muted signs of inflation despite bustling strong growth led by Germany. That very growth is adding to speculation that hawkish members of the Governing Council will begin to push harder for policy tightening in 2018.
Whether that pans out or not will, not unlike in the case of the Fed, depend on whether strong economic growth translates into wage inflation and pushes prices higher.
The Bank of England is a bit of an outlier among this group of central banks. While the BoE faces a similar problem of low wage inflation, it is the only one who has seen headline inflation soar past and remain far beyond its target, placing a serious squeeze on households’ cost of living.
Although the BoE eventually undid the rate cut implemented after the UK voted to leave the European Union, its policymakers remain reluctant to make further moves in tightening monetary policy due precisely to the uncertainty surrounding the Brexit negotiations.
The bank’s Monetary Policy Committee insisted in its December meeting that inflation had peaked at its most recent reading of 3.1%.
At the moment, markets do not expect the BoE to raise rates again until towards the end of 2018, when it will add another 25 basis points.
The BoE’s future actions do seem largely out of its control as policymakers wait to see if Brexit negotiations progress smoothly or get completely derailed. A successful outcome from an economic standpoint of the trade talks could push the BoE towards a more hawkish stance in 2018, while any unfavorable accord could see the British central bank forced back into the position of employing its arsenal to support the UK economy, already near the tail end of growth among G7 members.
With the absolute deadline for Brexit not arriving until March 2019, and thoughts that there may be a transition period of up to two years, 2018 looks set to pass with the BoE very much in limbo, albeit with a token hike near the end of the year.
The BoJ provides yet another example of “steady as she goes” for 2018 as the Japanese monetary authority made no changes to monetary policy last year. In its December meeting, the BoJ held its short-term interest rate target at minus 0.1% and the 10-year bond yield target around 0%.
BoJ governor Haruhiko Kuroda sought to make abundantly clear that ultra-loose policy would continue until it could get inflation back on track and swept aside criticism that prolonged easing could derail Japan’s banking sector.
“Our most important goal is to achieve our 2 percent inflation target at the earliest date possible,” Kuroda told the press conference following the December decision. “We won't raise interest rates just because the economy is improving.”
Market analysts expect the BOJ to keep both short-term rates and the 10-year bond yield target unchanged at least until the second half of 2019, while most economists believe the Japanese central bank will not begin scaling back its stimulus until late 2018 or after.
Though Kuroda did his best to reassure markets that the BoJ will lag behind overseas peers and set Japan’s path for 2018 monetary policy practically in stone, there are still a couple of wrenches that could be thrown into the system this year.
First off, Kuroda’s term at the helm officially ends in April and any shift at the rudder could shift market perceptions. However, given signs of Japanese Prime Minister Shinzo Abe’s strong support, there seems little likelihood that Kuroda won’t be reappointed.
Secondly, and against the global trend in the removal of accommodative policy, it should be noted that BoJ member Goushi Kataoka dissented for the third straight meeting in December, arguing that the BOJ should buy long maturity bonds so that yields for durations of 10 years and longer fall further.
Coupled with Kuroda’s vehement insistence on the need to at least maintain ultra-loose policy, Katoaka’s more dovish calls could—though the probability seems remote—provide a roadblock for Japan’s return to normalization.
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