MAJOR international institutions and almost all market consensuses are forecasting the global economy, which was firing on all cylinders in 2018, is now looking to grow less strongly in 2019, moving from a synchronised growth to less synchronised global growth.
Global trade tensions, monetary policy uncertainty in advanced economies, downside risks in Europe and an apparent slowdown in China are cited as key factors to watch in 2019. These anxieties come at the time when the US economy is experiencing some real feedback effects from a tightening of financial conditions, volatility in the stock market, the strong dollar, the impact of higher cost of borrowing on interest sensitive sectors.
Global central bankers must figure out if and how they would calibrate their monetary policy to mitigate some of their unwanted side effects on growth and domestic demand.
Essentially, the central banks have to make careful assessment about the balance of risks between growth and inflation (financial imbalances). This boils down to whether they are behind or ahead of the interest rate curve without significantly reducing demand for goods and services.
Given the uneven nature of the economic expansion, the central banks’ monetary response will vary, taking into consideration an assortment of risks. The decisions will have a profound influence on global financial flows and foreign exchange markets.
Over-tightening of interest rates could temper the already slowing economic growth while easing interest rates too early could encourage more risks taking. At best, keeping interest rates at a neutral level that neither hastens nor slows growth. This is because of maintaining low interest rates for too long could stir up more unsustainable bubbles and asset inflation down the road.
Broadly, in our view, central banks should take a “gradual, well-communicated, and data-dependent path” toward higher interest rates.
Throughout 2019 and beyond, the Fed will face an upheaval task to calibrate the interest rate path given lingering concerns about how much further the US economic expansion has room to run. The Trump administration’s fiscal stimulus measures, which had boosted economic growth in 2017-18 have peaked and will fizzle out in late 2019.
Will the Fed take a breather in 2019? The Fed’s forward guidance on the future rate path has been pared down to two hikes for this year from three previously, underscoring that the Fed policy makers take cognizance about the economic risks and financial market volatility shadowing the US economy.
Amid the seemingly dovish about future interest rate hikes, the Fed’s future rate moves are expected to be data dependent and will likely to hit the pause button in the second half of 2019.
While the European Central Bank (ECB) has halted its four year’s quantitative easing in December 2018, there is considerable degree of uncertainty as to when the ECB would begin the journey of raising interest rate.
Given the numerous economic and political risks as well as the elevated Brexit uncertainty, ECB is not confidence enough to start removing interest rate accommodation anytime soon.
With the elevated Brexit risk, Bank of England is likely to hold fire on rates for now though it has signaled that an “ongoing tightening of monetary policy” may be needed over the next three years to bring inflation down to the 2% target if the UK has smooth transition following Brexit.
Bank of Japan is expected to continue maintaining highly monetary easing given the risks of slowing economic growth and sluggish inflation outlook.
The People’s Bank of China (PBoC) has taken monetary measures via the reduction in reserve requirement ratio (RRR) to free up more funds in the market as well as supporting financial assistance to the small and private enterprises. Barring the outcome of the trade truce talks with the United States by the March 2 deadline, PBoC is expected to maintain a balanced or slightly accommodative monetary stance this year to keep economic growth at above 6%.
Asian central banks are expected to maintain somewhat easy interest rate policy given weaker economic growth and tepid price pressures. With the Fed looks toward topping its interest-rate hiking cycle in 2019, it will lessen foreign exchange selling pressure in countries like Indonesia, the Philippines and India.