How will central banks respond to the Delta variant?
- The highly transmissible coronavirus variant will complicate the Federal Reserve’s attempts to tread a fine line between retaining accommodative monetary policy and managing inflation
- China, on the other hand, has more room for monetary policy manoeuvring
China’s economy will not be immune, but Beijing has more flexibility than many to make necessary monetary policy adjustments.
Nevertheless, there will be economic implications from the virus’ resurgence and markets have already woken up to the risk. Amid clear evidence of the greater transmissibility and spread of the Delta variant, reflation trades have been unwound recently across asset classes, as the investing narrative has shifted towards the idea that the global economy’s initial post-pandemic rebound has already peaked.
But such is the scale of the Delta variant’s spread, central banks and governments will also have to think about fiscal and monetary policy responses.
Treading that line may just have got harder with the US Centres for Disease Control and Prevention now stating that the Delta variant became the most dominant strain of Covid-19 in the United States over the two weeks ending July 3.
Indeed Atlanta Fed president Raphael Bostic acknowledged on July 7 that if the spread of this more virulent strain does lead to “spikes in infections”, it could result in less economic activity and mean that the US “recovery is going to be a lot smaller”.
The situation poses significant challenges to the US central bank.
China too faces challenges but it still has plenty of monetary levers to pull if needed. Others may be more restricted in their policy options.
In comparison to others, as Sun Guofeng, head of the monetary policy department at the People’s Bank of China (PBOC) recently noted, China’s central bank’s balance sheet did not greatly expand last year in response to the pandemic. “In 2020, the balance sheet of the [PBOC] expanded by only about 3 per cent,” Sun wrote, “while those of the Federal Reserve, the European Central Bank and the Bank of Japan expanded by 77 per cent, 50 per cent and 24 per cent.”
That should give Chinese monetary policymakers more room than others to adjust monetary policy settings as the economic consequences of the global spread of the Delta variant of Covid-19 become clearer.
The PBOC’s move will release 1 trillion yuan (US$154 billion) worth of liquidity into the interbank system, liquidity that can then be directed into more credit for small Chinese companies in need of support. This is Beijing taking monetary policy action in light of the changed circumstances.
Markets may continue unwinding reflation trades amid concern over the economic consequences of the spread of the Delta variant. Policymakers around the world might also decide additional monetary support measures are required. But when it comes to countering the economic impact of the Delta variant of Covid-19, few countries, if any, still have at their disposal as many monetary policy options as China.
Neal Kimberley is a commentator on macroeconomics and financial markets