Central Banks

Tightening is coming – Wall Street tells investors to brace for steepest rate rises since 2006

Citigroup and JPMorgan Chase forecast average interest rates across advanced economies will climb to at least 1 per cent in 2018

PUBLISHED : Monday, 11 December, 2017, 5:37pm
UPDATED : Tuesday, 03 July, 2018, 9:47pm

Wall Street economists are telling investors to brace for the biggest tightening of monetary policy in more than a decade.

With the world economy heading into its strongest period since 2011, Citigroup and JPMorgan Chase predict average interest rates across advanced economies will climb to at least 1 per cent next year, in what would be the largest increase since 2006.

As for quantitative easing, which marks its 10th anniversary in the United States next year, Bloomberg Economics predicts net asset purchases by the main central banks will fall to a monthly US$18 billion at the end of 2018, from US$126 billion in September, and turn negative during the first half of 2019.

That reflects an increasingly synchronised global expansion finally strong enough to spur inflation, albeit modestly. The test for policymakers, including incoming Federal Reserve chair Jerome Powell, will be whether they can continue pulling back without derailing demand or rocking asset markets.

“2018 is the year when we have true tightening,” said Ebrahim Rahbari, the director of global economics at Citigroup in New York. “We will continue on the current path where financial markets can deal quite well with monetary policy but perhaps later in the year, or in 2019, monetary policy will become one of the complicating factors.”

A clearer picture should form this week when the Norges Bank, Fed, Bank of England, European Central Bank and Swiss National Bank announce their final policy decisions of 2017. They collectively set borrowing costs for more than a third of the world economy. At least 10 other central banks also deliver decisions this week.

The Fed will dominate the headlines on Wednesday amid predictions it will raise its benchmark by a quarter of a percentage point. Departing chair Janet Yellen is set to signal more increases to come in 2018. On Thursday, the Swiss National Bank, BOE and ECB will make decisions in quick succession although each is forecast to keep rates on hold.

There is likely to be more activity next year as Citigroup estimates the advanced world’s average rate will reach its highest since 2008, climbing 0.4 percentage points to 1 per cent. JPMorgan projects its gauge to rise to 1.2 per cent, a jump of more than half a percentage point from the 0.68 per cent at the end of this year.

Citigroup expects the Fed and its Canadian peer to move three times and the UK, Australia, New Zealand, Sweden and Norway once. JPMorgan is forecasting the Fed will shift four times.

Behind the shift are expectations that the world economy will expand by about 4 per cent next year, the best since a post-recession bounce in 2011. Among the accelerators are falling unemployment, stronger trade and business spending, as well as a likely tax cut in the US.

The International Monetary Fund predicts consumer prices in advanced economies will climb by 1.7 per cent next year, the most since 2012, although it remains below the 2 per cent most central banks view as price stability.

The global tightening will still leave rates low by historical standards and central banks may ultimately hold fire if inflation stays weak. Neither the ECB nor the Bank of Japan are currently expected to lift their benchmarks next year.

Past and ongoing bond buying will cushion the withdrawal of stimulus elsewhere, as will easing by some emerging market central banks. Russia and Colombia may this week follow Brazil in cutting their benchmarks.

While BOE governor Mark Carney and ECB president Mario Draghi pivoted away from easy money without roiling financial markets, the calm may not last. The Bank for International Settlements said this month that policymakers risk lulling investors into a false sense of security that elevates the risk of a correction in bond yields.

Investors are already less bullish than most economists. In the US, where inflation has shown some signs of slowing, the market sees about two quarter-point rises next year, according to federal funds futures contracts. There is also speculation that the bond yield curve may even invert as long-term borrowing costs fall below short-term ones, a trade which sometimes foreshadows a recession.

Torsten Slok, the chief international economist at Deutsche Bank in New York, is betting that “quantitative tightening” will hit markets in the second quarter. That is when he assumes US inflation takes off and the ECB signals an end to bond buying.

“We see 2018 as a pretty key year for normalisation,” said Victoria Clarke, an economist at Investec in London. “It’s going to be quite challenging for central banks to get the balance right on how much to do.”