No more low for central banks


Fed reserve bldg

WE are seeing global central banks shifting away from an ultra-low interest rate environment, especially in advanced economies, including the Federal Reserve (Fed), (pic) Bank of England (BoE), and European Central Bank (ECB).

As the economy recovers alongside a rising consumer price level, the threat of red-hot inflation chipping away consumers purchasing price had nudged central bankers to roll back their accommodative monetary policy.

Monetary policy tightening was discussed in mid-2021 as more economies were reopened and people were vaccinated against Covid-19. Nonetheless, economic recovery was uneven among different economies, creating imbalances in supply and demand. In an earlier assessment by the Fed, the sudden surge in inflation was seen as “transitory”, a view that is shared by most central bankers during that time. The term refers to prices for goods and services that experience a temporary pick-up before moderating. Nonetheless, after Russia’s invasion of Ukraine, and the ongoing supply chain issues, inflation is no longer transitory but persistent.Added to elevated transportation costs and continuous disruption in global supply chains as China sticks to its zero-Covid policy, the cost-push factors had raised inflation reading to multi-year highs.

For example, the US price level has reached its highest in 41 years, mirroring the situation we witnessed in the 1980s while South Korea’s prices grew at the fastest pace in over 13 years. Intuitively, consumers will alter their spending behaviour if they expect prices for goods and services to continue rising. Furthermore, this is negative for businesses as their margins are being pressured by falling revenue and increasing cost at the same time, which could also alter their investment decisions. Ultimately, this situation will result in slowing economic growth and clouding growth prospects for the months to come. As such, we may consider the act by central bankers in raising their key rates to be a “correct” move although some would argue that certain central banks are already behind the curve.

By pushing the interest rate higher, it will constrain demand through higher lending rates and eventually, stabilise inflation as firms must push prices downward. This would work in theory. But in practice, it is much more complicated since changes in interest rates do not affect prices directly. It would only affect consumers and business’ behaviour through supply and demand.

The Fed began its tightening cycle in February this year with a 25 basis points (bps) rate hike move to 0.25% to 0.5%, the first rate hike since 2018, and later by a further 50 bps in May’s meeting to the 0.75% to 1% range.

Fed chair Jerome Powell signalled that the move was appropriate to rein in the breakaway inflation as the US economy is strong enough to weather the tighter financing condition. Powell and most of the Federal Open Market Committee voting members emphasised that keeping inflation down should be the main priority, and they will not back away from making more aggressive rate hikes in the future.

Powell US FedPowell US Fed

The BoE started raising its interest rates to 1% in its latest meeting, marking the fourth consecutive move and its highest level since 2009. Interestingly, the BoE has emphasised that despite the aggressive rate hikes, it is unlikely that inflation will cool down.

The UK’s experience is an outlier, as the economy now is already feeling the effects of Brexit.

The Reserve Bank of New Zealand (RBNZ) hiked its official cash rate to 2%: its highest level since late 2016, in a 50 bps move as expected by the market. As a country that is mostly dependent on the import of oil, the higher the global benchmark Brent price is, the further inflation will feed into the economy. For perspective, New Zealand’s inflation rate is running at 6.9% in the first quarter of 2022, the highest in 30 years, and mainly pushed up by the prices of utilities and housing.

Bearing the brunt

South Korea, who has structural similarities with New Zealand when it comes to the usage of oil, is also bearing the brunt of surging oil prices.

The Bank of Korea (BoK) raised its benchmark interest rate on Thursday and signalled that it would tighten its policy further as it keeps up its fight against high inflation. The benchmark seven-day repurchase rate was raised by 25 bps to 1.75%, a level last seen in June 2019, after an increase at the previous meeting in April. Amid recovering from the pandemic, the South Korean economy expanded 3.1% in 1Q22 while inflation hit a 13-year high in April at 4.8% from a year earlier, well over its 2% annual target.

The fifth rate increase since August 2021 was in line with our expectation, The bank indicated more rate increases as it sharply raised its inflation forecast for this year and trimmed its growth outlook. The inflation outlook was revised to average by 4.5% for 2022, much higher than the previous projection of 3.1%, and the country’s growth rate is expected to land around 2.7% this year, compared with its initial forecast of 3%. However, it was a different story for Bank Indonesia (BI). During the pandemic, the central bank cut interest rates by a total of 150 bps to a record low of 3.5% and injected billions of dollars into the financial system due to the burden-sharing programme coordinated with the government.

Eventually, as most countries started to observe higher energy price kicking into the economy, Indonesia’s long-time energy subsidy helped the country to alleviate those effects, especially for the poor income population.

This could explain why BI is one of the few central banks in the region that have not made any adjustments to the policy rate.

The latest inflation stood at 3.47%, which is now in the upper bound of the 2% to 4% target range. It is hard to see BI deviating from the rest, where eventually the central bank will adjust the policy rate in the future.

Bangko Sentral ng Pilipinas (BSP, the Philippines central bank) also responded to the pandemic by slashing interest rates all the way down to 2%, the lowest level in history.Bangko Sentral ng Pilipinas (BSP, the Philippines central bank) also responded to the pandemic by slashing interest rates all the way down to 2%, the lowest level in history.

Bangko Sentral ng Pilipinas (BSP, the Philippines central bank) also responded to the pandemic by slashing interest rates all the way down to 2%, the lowest level in history. In April 2022, inflation in the Philippines increased to 4.9%, which has already breached the target range of% to 4%. The BSP has made one 25 bps rate hike this month and more could come depending on the inflation outlook.Pre-emptive measure

The Monetary Authority of Singapore took a pre-emptive measure before the Ukraine conflict and China’s zero-Covid policy began. The first tightening was back in October 2021 due to positive economic prospects. The second round was in January, and a recent one in April as global commodity prices picked up substantially. The Bank of Thailand (BoT), however, is in no rush to raise rates soon even though inflation stood at 4.65% in April: the highest reading relative to the past 13 years. The reason for such lack of urgency was more on supporting growth momentum. However, the prospect of high inflation and the weakening of the baht recently could change the BoT’s stance.

Robust growth

Back home, although an interest rate adjustment was expected, Bank Negara made the move sooner than expected, on expectations of robust growth in the months to come. We expect the central bank to adjust the overnight policy rate one to two more times this year, bringing the interest rate to 2.25% and eventually to 2.5%.

As most major central banks in the advanced economies are tightening their monetary policy to combat inflation, most central banks in the region are also following the same path for the same reason.

Plus, the weakening of currency and interest rates differential are also pushing several central banks to adjust their interest rates. While, such adjustments are anticipated as inflation continues to gather momentum in the months to come, the question is to what level the central banks will push the interest rates without causing an adverse effect on the financial market and the economy.

For FX enquiries, please contact: ambank-fx-research@ambankgroup.com

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