Think Big: The ‘next evolution’ of monetary policy is approaching — how far will rates rise?
As 2021 draws to a close, central banks are turning their attention to the “next evolution” of macro policy, CBA says.
For most Western economies, post-COVID growth is strong and inflation is now tracking above the consensus target rate (2-3%) for the first time in over a decade.
It means policy makers are starting to “eye the exit” from the extreme monetary policy settings implemented during the pandemic.
Rates are currently at rock-bottom — 0% (technically 0.1% in Australia) — which raises two questions:
Firstly, how fast will they rise? And secondly, how high will they go before the next rate-hike cycle is complete?
In research this week, CBA assessed the rates outlook for each of the world’s largest economies.
Hike cycle: 1.5%
Compared to other advanced economies, the US is already seeing stronger inflation prints.
CBA is “more confident US inflation will persist above its central bank’s target, compared to other economies under our coverage”.
Wages are climbing, people are quitting their jobs for higher-paying roles, and unemployment is falling.
The US Fed has already begun heading towards the exit, telegraphing the wind-back of its bond purchase program which is expected to start at the end of this year.
On the rates front, CBA reckons they will start to lift at the end of next year.
But don’t expect a return to the pre-GFC days, when rates were in the mid-single digits.
“We estimate the FOMC will lift the Funds rate to 1.50% by December 2023,” CBA said.
“However, the risk is a higher peak in the Funds rate if US inflation remains persistently high.”
Hike cycle: 1.25%
In separate research recently, CBA economist Gareth Aird presented a timeline for possible RBA rate hikes.
The RBA is holding strong to a 2024 timeline for the first raise, although right now the market disagrees.
Before the NSW/Victoria lockdowns, Aird said a post-COVID bounce back would see that RBA hike as soon as late-2022.
CBA has since pushed that forecast back to May 2023. It currently forecasts the domestic hike cycle will top out at 1.25% in 2024.
Canada hike cycle: 1.5%
UK hike cycle: 1.25%
Like other Western economies, the UK has emerged from the pandemic with high household savings rates, and inflation tracking above the 2-3% target.
The analysts say UK inflation growth should ease next year, although the current energy crisis may create more cost-push inflation over the next six months.
CBA expects the Bank of England will be the first to move, commencing its rate-hike cycle in February 2022.
“We then anticipate two more 25bp hikes in both 2022 and 2023, taking the Bank rate to 1.25% by the end of 2023,” CBA said.
Similarly to its neighbour the US, Canada is also seeing upward pressure on inflation due to higher petrol prices and supply side bottlenecks.
The Bank of Canada is expected to start reducing its bond purchase program this month, and start hiking rates in July next year. But if inflation climbs to the upside, that could be moved to April.
“We then expect four additional 25 basis-point hikes over the next two years, with a terminal rate of 1.50% by July 2023,” CBA said.
Among the world’s largest economies, that concludes the post-COVID rate hike outlook.
Analysts still have no expectations for Japan to raise rates, as its economy continues to battle structural deflationary forces.
Europe is starting to see some inflation emerge, but the European Central Bank will be “late to withdraw stimulus in our view”, CBA said.
“A modest increase in interest rates is possible by late 2023, but we favour early 2024,” the analysts said.
Lastly, CBA expects policy makers to adopt a “mild easing bias” as the economy transitions away from commodity-heavy infrastructure.
The tool they will use is a reduction in the Required Reserve Ratio (RRR) — the minimum ratio banks are required to maintain to lend.
“Interest rate cuts can undo progress made on structural reforms by encouraging excessive leverage,” CBA said.
“Hence, we expect the policy interest rates to remain unchanged.”