Central-bank tap-turning risks parch the recovery

LONDON (Reuters) – The global recovery has powered through into the new year, bringing with it expectations for tighter monetary policy, something that tends to be followed eventually by recession – and the last time around, financial and economic shock.

Major central banks such as the US Federal Reserve, the Bank of England and the Bank of Canada have already raised interest rates, while the European Central Bank is moving ever closer to unwinding its own ultra-easy monetary policy.

So far, those banks have been reluctant to move rapidly, instead leaving the monetary taps open to try to drive up stubbornly low inflation and maintain growth.

“The danger is that we end up stoking bubbles, which ultimately have even more disastrous long-term consequences,” said Peter Dixon at Commerzbank.

But if they tighten policy too soon, or too fast, they risk choking off the synchronized global upturn that has delighted policy makers, politicians and vast swathes of jobless people who have finally got back into work.

If the current US economic expansion, already 102 months long, lasts another two years as many expect, it will be the longest in more than 150 years.

Already solid US growth will be lifted this year by tax cuts, something most economists polled by Reuters say is not warranted at this late stage of the business cycle.

But it’s not just the US economy that is steaming ahead. Dozens of countries are now enjoying economic growth well above their 10-year moving averages.

HSBC economists noted in a recent report that periods in which the majority of countries are expanding at above their long-run trends tend to be associated with heightened monetary and financial risks.

“Synchronized global growth has tended to occur during only three stages in each economic cycle: in the initial recovery from recession; the years immediately preceding the next recession; or ahead of some sort of financial trauma,” they said.

While some individual forecasters have racked up impressive track records for accuracy, economists as a group consistently fail to predict recessions.

In a late-January survey, they said the global economy would expand 3.7% this year and 3.6% in 2019, faster than they expected in October.

“Global growth has been accelerating since 2016, and all signs point to a continuous strengthening of that growth in 2018 and next year,” IMF Managing Director Christine Lagarde told a news conference at the World Economic Forum annual meeting in Davos, Switzerland, last month.

Meanwhile, stock markets across the world repeatedly set record highs in 2017. But they have had a turbulent start to the year.

“It’s hard not to see recent market turmoil as a taste of what’s to come as we enter a world in which central-bank support for asset prices can no longer be taken for granted,” Alliance Bernstein economists told clients.

Some 23% of investors believe the biggest tail risk for markets is a policy mistake by the Federal Reserve or ECB, according to a December survey by Bank of America-Merrill Lynch.

PUNCH DRUNK

The Fed is almost certain now to raise rates three times in 2018, in line with the central bank’s own projections, a Reuters poll found, even though some US policy makers are still worried about weak wage inflation and overall price pressures. The risks are increasing that it will deliver four hikes.

Polls also found that the Bank of England will increase borrowing costs in May, earlier than previously thought. And while it will be a long wait before the ECB raises interest rates, it is expected to end its asset purchases by the end of the year.

Those predictions for tightening come despite persistently below-target inflation. Policy makers say those price pressures will come and that robust growth rates can withstand tighter policy.

Yet who can forget the ECB raising borrowing costs in July 2008, just before the biggest financial crisis in recent memory and as European growth was already at a near standstill, only to be forced into slashing rates months later. It flip-flopped again in 2011. The world is different now than it was then, however, said Commerzbank’s Dixon, with many of the imbalances and problems that afflicted economies resolved.

“The fact is, you can’t continue to run economies on this kind of ultra-expansionary monetary policy forever,” he said. “You have to take away the punch bowl now in order to prevent a bigger hangover later.”

‘The danger is that we end up stoking bubbles, which ultimately have even more disastrous long-term consequences’