TOWARDS NORMALISATION – BUT WHAT ABOUT THE SUPPORT?
BY LONDON & CAPITAL
As the global economy staged a vigorous recovery, we imagine policymakers all over the world would be patting themselves on the back. They have helped navigate the economic and financial systems through a period for which nobody could have drawn up a more effective disaster recovery plan.
We believe growth will be strong in 2021 and this momentum is likely to spill over into the first half of 2022. However, as we move towards a more normalised environment, some key questions remain following this period of extraordinary government and central bank support.
How quickly will accommodative monetary policy be removed?
Chief among these is when the central bank accommodation will end. This has been a particular area of focus especially after the US Federal Reserve’s (Fed) June Federal Open Market Committee meeting. This may well be seen as a seminal moment in re-setting the Fed’s monetary agenda.
It acknowledged that the economy has made substantial progress across many segments, but expressed concern about the labour market. In a slightly more hawkish tilt, it implies that the Fed may now be unwilling to tolerate a sustained period of inflation overshooting its 2% target. This is despite fairly broad hints since the beginning of the pandemic that they would be willing to do so.
We see this tilt as the Fed flexing its muscles and reminding the world that they are very firmly in control and in no mood to tarnish its hard-earned image.
In essence, we learned that:
- The Fed will not start reducing the rate at which it purchases assets until late Q1 2022 or Q2 2022. This will trim down the pandemic support – not the pre-pandemic quantitative easing.
- The overall policy will remain highly accommodative for some time ahead. The return to full normality is some way off, to be dictated by economic growth.
What does this change in tone mean for actual monetary policy?
In this post-pandemic recovery, there are three strands to the normalisation we can expect to see:
- The Fed has already dialled back its emergency support for businesses and consumers.
- The Fed cut its key interest rate by 150 basis points in the aftermath of the pandemic lockdown. While it signalled it will take a third of this loosening away in 2023 (bearing in mind that this timing may change dependent on the path of the economy) policy will still be looser than it was in February 2020.
- The Fed will continue expanding its balance sheet for some time ahead, even with the effect of reducing the rate of its asset purchases.
The inflation path will be pivotal to central bank policy and we will not be complacent in our response either. We are keeping a keen eye on forward-looking indicators such as inflation expectations, while also following corporate intentions.
To find more about the latest house views from London & Capital’s Investment Desk, read the full AndPapers Q3 2021 here.
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