Prior to the COVID outbreak, the main topics of conversation and concern were low growth and low inflation, with low productivity and ageing demographics hampering the developed economies. Central banks have been forced into successive long periods of monetary support with asset purchases seemingly a permanent feature, just like the Bank of Japan. But this support was necessary as regulators were successfully reshaping the financial sector post-2008, whilst the corporate sector was also restructuring their balance sheets.
Looking ahead, we are still dealing with many of the same problems as before. Potential growth rates are still under pressure, compounded by newer restrictions that will prevent large-scale immigration to boost labour supply (a key component of potential growth rates). Regulators are adding to the economic burden as they demand banks to further strengthen their balance sheets from an already strong position, withdrawing liquidity from the wider economy.
The central banks will also be wary of deploying the Quantitative Easing tool again, even if growth is lower and inflation falls back towards target in 2024. Forward looking interest rate expectations are beginning to shift, with the prospect of rate cuts into 2024 beginning to feature. However, central banks will not be cowered into stopping now as demand needs to be constrained and blinking early will merely make the situation worse.
We believe that unless there is a real liquidity issue, the era of large-scale fresh asset purchases is finally ending.
As we move ahead over the next few quarters, we would expect the call of low growth and lower inflation to get even louder.