As the year has progressed the global growth outlook has become increasingly mixed. Amongst the developed economies growth in America is looking increasingly solid while Japan and the Euro zone continue to struggle. That is leading to an increasing divergence in monetary policy as the US Federal Reserve ends its quantitative easing program and looks likely to raise interest rates next year while the Bank of Japan and the European Central Bank are stepping up their asset purchases. (For more on central bank asset purchases click here for a recent Investment Insights from our Head of Investment Strategy Keith Poore).
With the recent cut in China interest rates
and the increasing likelihood of the same in India monetary policy in the key
emerging economies is also on a divergent path as Brazil and Russia continue to
hike rates in the face of persistent inflation pressures and, in the case of
Russia, concerns about financial stability.
The surprise (at least for me) cut in China interest
rates is a clear signal that policy makers are concerned the more targeted
easing measures to date will be insufficient to achieve the desired
growth/inflation outcome. Indeed the
move to cut rates is likely to be on the back of recent low inflation which has
led to an increase in real interest rates and the fact that recent measures to
lower mortgage interest rates have been ineffective. Recent appreciation in the exchange rate,
especially against the Yen, was probably also a factor.
It remains to be seen what impact this will
have on the real economy. While the rate
cut is probably more likely to have an impact on borrowing costs for larger
corporates than SMEs (who are more reliant on the shadow banking sector for
funding) it is a clear signal that policy makers want to get the cost of
capital down. Having now started,
further rate cuts appear more than likely.
Concern that policy-makers are abandoning the
reform process in favour of cyclical support for the economy is ameliorated by
the move to widen the deposit ceiling from 10% to 20% which, while subtle, is a
further step towards interest rate liberalization.
While the recent weakness in the property
market is a clear concern, I’ve been pretty comfortable with the broader
slowdown in China growth. I’ll stay
comfortable so long as lower growth is a reflection of continuing
implementation of the reform program that, while leading to lower growth over
time, will make that growth more sustainable.
Interest rate cuts won’t preclude continuing
efforts to increase fiscal spending and attempts to get local government to
increase infrastructure spending. These
measures were successful in supporting growth earlier this year and will likely
do so again, at least once we get past the likely further weakness in
industrial production in November reflecting measures to reduce pollution ahead
of the November APEC meeting.
Meanwhile the growth/inflation outlook in
India is moving increasingly in favour of interest rate cuts. Inflation has
moved sharply lower over recent months Inflation fell in India during October
primarily reflecting a drop in food price inflation. The lower inflation outturns will ease the
pressure on the Reserve Bank of India, which recently introduced an inflation
targeting regime. That said, interest
rate cuts are probably more a 2015 story and require the new Government to
maintain a strong fiscal discipline.
The Central Bank of Russia (CBR) has been
raising its policy rate aggressively to offset the inflationary impact of the
weakness in the currency. While currency weakness is a good thing when
adjusting to an external shock, it can move too far too fast. Growth has held up surprisingly well so far
(+0.4% qoq in Q3, +0.7% yoy) although we don’t expect that will last. The uncertainty of the political/sanctions
environment will continue to be a drag on business investment, consumers are
feeling the impact of higher inflation through lower real incomes and the oil
price is sharply lower.
CBR is taking the right approach however by
ensuring financial stability while at the same time managing a decline in the
currency that allows the economy to adjust gradually. The bank also appears keen to build its
inflation fighting credentials in the lead in to the adoption of a formal
inflation targeting regime next year.
In Brazil the central bank resumed interest
rate hikes at the end of October with a 0.25% increase in the Selic rate to
11.25%. As I’ve said many times before
Brazils inflation problem is largely structural – the good news is the central
bank is responding appropriately which throws down the challenge to the freshly
re-elected President to engage in meaningful structural reform of the labour market
and network industries in particular. I expect the Selic rate will be closer to 12% before long.
As an economist with rather conventional (old
fashioned?) views about the role of central bank’s and monetary policy it is
encouraging that the key emerging market central banks are responding to their
own set of circumstances in a quite orthodox fashion. While worrying about much needed structural
reform in many countries, including the key emerging economies, my concern was emerging
market central banks would take their eye off the inflation ball. You will be pleased to know I’m becoming
increasingly less worried about the central banks although I’m still worried about