There will be more market attention than usual this week on the central bank meetings in New Zealand and Norway. Neither is expected to alter their overnight borrowing costs, but the merest signs of hawkishness will add to the growing impression that policymakers are looking at ending years of monetary easing.
The Federal Reserve has been out on its own, raising overnight interest rates on four occasions by 25 basis points in 18 months while the central banks of other developed countries doggedly sat on their hands.
Not any more. Global growth is picking up, and G10 currencies are making gains against a soggy dollar. The euro, the Danish krone and the Australian dollar have all risen by at least 5.5 per cent since the start of the year and in recent days economic data from Norway and upbeat comments from the Reserve Bank of Australia are making a stronger case for monetary tightening.
According to George Goncalves at Nomura, central banks realise they have “overstayed their welcome” and need to become more hawkish, peel back layers of excess liquidity and stem the outsized flows that have supported fixed income.
“It might not seem obvious now,” said Mr Goncalves, but markets will look back at this moment as “a pivotal point in moving further away from central bank-supported bond valuations”.
The first to tip the scales definitively in favour of rate rises is the Bank of Canada. In co-ordinated messages, the BoC’s top two policymakers told the market to prepare for rate rises, and investors responded by driving the Canadian dollar to its highest level in three and a half months.
When the Bank of England followed that with a surprise split decision last week, analysts smelled a broader policymaking shift.
Even Sweden’s Riksbank, which has persistently shrugged off calls to shift away from negative interest rates, may soon find the argument compelling. The economy is very strong, with GDP running at 3 per cent, says Robert Bergqvist, SEB Group’s chief economist.
“But companies ask why the Riksbank is printing more krona. Unconventional monetary policy is adding more uncertainty,” he says. “Swedish monetary policy has become counterproductive.”
Three reasons might give some investors cause for scepticism. First, inflation remains stubbornly unwilling to enter policymakers’ target ranges, a point illustrated by slumbering long-dated bond yields. “Inflation is still missing everywhere,” says Ugo Lancioni, portfolio manager at Neuberger Berman.
Second, wider and meaningful policy normalisation will need participation from the European Central Bank and Bank of Japan and there is little to no encouragement from either about the unwinding of monetary easing.
Third, there is good reason why BoE hawkishness does not fit into the broader outlook of other central banks. Sterling’s post-Brexit devaluation is testing the BoE’s tolerance for higher than expected inflation, and amid political uncertainty, poor data and weak wages growth its dissenting policymakers may be looking at an expedient way to support the pound.
The pound duly rose, only to fall after BoE governor Mark Carney said “now is not yet the time” for monetary tightening.
According to Stephen Gallo at Bank of Montreal, last week’s dissent was “a convenient way for the BoE to reassert its inflation-fighting credibility without going as far as commencing a rate hiking cycle”.
Such reasons for scepticism may not stand the test of time. The Fed is less bothered than the markets about below-target inflation and, according to Yianos Kontopoulos, UBS macro strategist, its tolerance for low inflation rates may have caused a significant downward shift in inflation expectations.
Other central banks may follow suit. Low inflation gives them options, Mr Kontopoulos points out. “ . . . they do not have to hike, but they choose to do so for purposes of monetary normalisation,” he says.
Investors expecting a stronger tightening signal from the ECB may not have long to wait. Nomura thinks “peak dovishness from the ECB has likely passed”, while Mr Bergvist points out how, despite a less expansionary Fed and the ECB continuing to buy assets every month, the euro is trending higher.
“There hasn’t been the impact on the currency markets that some central banks have been aiming for,” Mr Bergvist says.
A policy shift from the ECB may be just the signal other central banks like the Riksbank and the Norges Bank have been awaiting. It may not come until September, but the fourth quarter is set to see rises in the euro and the krone currencies.
Only the yen seems destined among major currencies to continue weakening. BoJ normalisation “remains years away”, say JPMorgan analysts.
Investors have waited patiently for central bank policy shifts, so when they come the moves will be gradual. Low interest rate environments have become the norm and portfolios huge, so moves to downscale easy policy will not be rushed, Mr Bergqvist expects.
“Monetary policy will continue to be very expansionary for many years,” he says. “We will have higher rates but still at very low levels.”