• The focus seems to be on demand destruction to take inflation back to target.
  • Fed set on a quick path to a terminal rate above.4%.
  • ECB and BoE following suit, even with weaker economies.
  • Some central banks (BoC and RBA) taking their foot off the pedal.

Central Bank policy has evolved over the past 12 months, from a cautious wait-and-see approach to jawboning at the start of the year to gradual tightening and finally to overdrive mode. The overriding intention is to bring inflation back to target as quickly as possible. In order to bring inflation back under control, policy has to be shifted from demand management to a form of demand destruction, as all of the added dangers, i.e., a soft landing can turn into a hard landing very quickly.

The change in tone and action implies that interest rates will continue to rise sharply through early 2023 and remain at this new elevated level for a prolonged period. That seemed to be the takeaway from the Jackson Hole symposium and, in particular, Jay Powell’s short comments that unnerved financial markets.

However, it would seem to us that in attempting to regain market credibility, central banks are adopting a “Rambo” style posture and talking up rate expectations even as economic fundamentals are changing. Of course, the situation is not easy as central banks have little or no influence on supply disruptions, but they can directly influence demand-led inflationary pressures and their subsequent impact on wages. The danger (and challenge) is that in attempting to gain credibility, policymakers go too far and inadvertently consign the global economy to a deeper recession. The markets are nervous, and just as they moved faster than official rates in anticipating tighter policy, they will inevitably move quickly in anticipating looser policy. There continues to be intermittent discussion over the Fed’s policy pivot, but it may be that as the economic backdrop shifts, the markets will force a pivot even if the Fed is fighting it.

To find more about the latest house views from London & Capital’s Investment Desk, read the full AndPapers Q4 2022 here.

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