One of our key themes for 2015 was the extent to which the monetary policy outlook amongst both the key developed and emerging economies would become divergent as growth and the inflation outlook diverged. That remains the case although in some countries there have been shifts in the timing of next moves. And in one important case, the central bank’s bias has recently shifted from tightening through neutral to an easing bias.
This post covers developed economies, emerging economies tomorrow.
US Federal Reserve
The latest FOMC statement shed little new light on the timing of “lift off” in US interest rates. However the tone of the economic assessment was more cautious reflecting the poor Q1 GDP result (+0.2% saar) and the uncertainty about how much of the weakness will ultimately prove transitory. Inflation measures remain mixed with core CPI and PPI ticking up recently but the Fed’s preferred measure of inflation, the core personal consumption expenditure deflator, remains low with the annual rate now at +1.3%.
However, the recent move higher in the employment cost index to +2.6% yoy, the highest rate since 2008, will give the FOMC confidence that inflation will likely move higher in time and that zero interest rates will soon no longer be appropriate. Given the weak Q1 GDP result a June start to the hiking cycle appears unlikely with September now the first likely opportunity for “lift-off”. But that requires data between now and then to show a meaningful bounce back in growth. The risk is lift-off occurs later still.
European Central Bank
Inflation and financial data out of the Euro zone data with credit growth improving and headline back up to zero following its brief flirtation with (technical) deflation. However core inflation remains undesirably low at only +0.6% yoy. Broader financial conditions continue their slow improvement with bank lending to the private sector recording its first annual increase in 3 years. For the past year to March, total credit has risen by +0.1%. Residential mortgage lending is mildly positive at +0.2% on an annual basis however corporate lending is still negative at -0.6% yoy.
We have recently revised up our growth forecast for this year to +1.4% but there is still a long way to go before the ECB can be confident of any sustained improvement in the inflation outlook. Spare capacity remains significant, most evident in the labour market with the euro zone unemployment rate at 11.3%.
We therefore expect inflation to remain low with little scope for the ECB to reduce its asset purchase program before September next year. In fact the risk appears to me that the program gets extended.
Bank of Japan
It’s a similar story in Japan where the recovery from last year’s recession is, at best, patchy. The latest disappointment was March industrial production which slipped again by -0.3% to be down by -1.2% for the past year.
The BoJ is maintaining a steady course with their aggressive monetary policy settings. April’s BoJ meeting reaffirmed the Yen 80 trillion annual asset purchase target. The BoJ marginally tempered their GDP growth forecasts by -0.1% for the next 2 years with Fiscal Year 2015 now at 2% growth and FY 2016 at 1.5% growth. The Bank also lowered its inflation forecasts and pushed out the time by which they expect to achieve their 2% inflation target to “around the first half of FY2016”.
We believe the BoJ remains overly optimistic on the outlook for both growth and inflation. As the data continues to undershoot their expectations, the BoJ appears likely to adopt additional easing measures.
Bank of England
Like the US the UK economy also suffered a weak Q1 growth result (+0.3% qoq) which is also likely to prove temporary, at least in part. Underlying momentum in the economy continues to look reasonably solid. However the weaker start to the year means that growth for calendar 2015 is now likely to come in softer than expected earlier at 2.7%.
Even with that slightly softer growth performance we expect spare capacity to continue to be absorbed with the unemployment rate likely to be close to 5% by the end of the year. While the BoE is on hold for the next few months, we expect an increase in interest rates in early 2016.
Reserve Bank of Australia
The Reserve Bank of Australia (RBA) lowered the official cash interest rate by 0.25% to 2.0% yesterday. This is the second interest rate cut this year with the cash rate now at a record low. Recent cuts reflect below trend growth and significant spare capacity as evidenced by the high unemployment rate.
However in its statement yesterday the RBA notably removed the previous comments indicating “a further easing of policy may be appropriate”. Hence the RBA now has a neutral stance on monetary policy, implying no immediate prospect for a further interest rate cut. The AMP Capital team in Sydney expects the RBA is likely to keep interest rates on hold over coming months.
Reserve Bank of New Zealand
The RBNZ adopted an easing bias at the April OCR review. More precisely the Bank says “it would be appropriate to lower the OCR if demand weakens, and wage and price-setting outcomes settle at levels lower than is consistent with the inflation target”. So it’s a bias to ease with a set of conditions that seems unlikely to be (collectively) met – at least in the near term.
That’s despite today’s labour market data coming in generally softer than expected. Employment growth came in much as expected at +0.7% qoq reflecting solid growth in the economy, however the unemployment rate remained unchanged at 5.8% (a drop to 5.5% was expected) given another strong increase in the working age population. The Labour Cost Index (unit labour costs) came in softer than expected too.
Looking ahead we expect GDP growth to remain relatively robust, though not as robust as the Bank, and for that to put pressure on resources in time, particularly in the labour market. That said there are downside risks to growth from weaker dairy prices (down again overnight) and the strong New Zealand dollar.
So I’m not ready to join the growing chorus for interest rate cuts, at least not yet. At this point I’m sticking to the view that interest rates are on hold for the foreseeable future and where interest rates go next is a story for next year. For more on the outlook for the New Zealand economy and interest rates in the next issue of New Zealand Insights.