Central banks take different paths to quell inflation
Central banks are caught between a rock and a hard place. Inflation is soaring globally alongside waning demand. Russia’s war in Ukraine caused a sharp shift in the source of inflation from being demand-led to a more supply-led inflationary environment. A supply-led inflationary environment beckons a different response from policymakers. Investors today are paying the high cost of policymakers delayed response to rising inflation.
The Russia/ukraine war continues to raise supply concerns for crude oil, refined products and natural gas resulting in higher energy prices. The knock-on effect of higher energy prices has been felt across the commodity spectrum – including industrial metals and agricultural commodities. Russia and Ukraine are the largest exporters of wheat, processed nickel, and fertilisers. As the conflict persists, we expect pressures on supply chains to mount. At the same time, China’s stubborn adherence to the dynamic zero Covid policy has led to reduced mobility, productivity and with that a weaker economic growth outlook. Global supply chains continue to be challenged with congestions at Chinese ports increasing.
Each of these central banks – the Federal Reserve (Fed), the European Central Bank (ECB), the People’s Bank of China (PBOC) and the Bank of England (BOE) are on very different journeys in their efforts to quell inflation. On 4 May, the Fed hiked rates by 50 Basis points (Bps) and signalled its intention to deliver an additional 100Bps in rate hikes over the coming months. The US labour market remains healthy, and employment is rising strongly. While the ECB faces a more uncertain growth outlook in Europe, labour markets are not as tight, but inflation is picking up more rapidly than expected.
As the ECB turns more hawkish, we expect rate hikes to follow in July, September and
at the turn of the year. The BOE appears to be caught somewhere between the Fed and the ECB. The UK growth story is much closer to Europe whilst the UK’S labour market resembles that of the US. The BOE has hiked four times since 2021. The dovish set of forecasts by the BOE suggest the Bank’s tightening cycle will be much less aggressive.
In contrast, weaker economic data alongside lower inflation should provide a window for policy easing by the PBOC. At the start of 2022, the market expected significant policy support to be announced to bolster the Chinese economy amid a deepening property sector slowdown. However, policy support by the PBOC has not been as generous as seen in previous cycles. The Chinese Renminbi has weakened in the face of Covid lockdowns. The PBOC will want to avoid further depreciation of the Renminbi at all costs. As it has warned before, a depreciating Renminbi would boost exports at the cost of lowering the consumption share of gross domestic product (GDP) by reducing the real value of household income.
We believe more policy support is on its way, but most of the focus will likely be on credit easing and fiscal stimulus. Infrastructure Capital expenditure (CAPEX) has emerged as a national policy focus, marking a potential inflexion point for China's infrastructure downturn. As we look to H2 2022, it's clear that the role of central banks in quelling inflation without tipping the economy into recession will take centre stage.