Central banks shuffling toward the exit

September saw a number of central banks continue to plot an exit from ultra-accommodative policies put in place during the pandemic. The Fed guided markets toward an imminent tapering announcement, and laid out a relatively abbreviated timeline to wind down net QE purchases by mid-2022. The FOMC is now evenly split on raising rates next year (we think it will) and anticipates gradual but steady rate increases in the following years. The BoE looks set to lead liftoff in the G7 and even opened the door to rate hikes before year end, although we think that isn’t likely until the second quarter of 2022. Not to be outdone, the RBNZ raised rates in October and looks set do so again at upcoming meetings. The BoC could shift to reinvestment-only as soon as its next meeting while the RBA slowed but extended its QE purchases in September. The ECB will evaluate the future of its pandemic-era asset purchases later this year.

These moves come as economic data flag some loss of momentum with early re-opening gains being exhausted and recoveries reaching a more mature stage. At the same time, persistent supply chain disruptions, further increases in energy prices, and growing reports of labour shortages suggest inflation will remain above central bank targets for a more extended period than previously thought. A post-FOMC selloff saw 10-year Treasury yields rise above 1.50% for the first time in three months, driven by higher breakeven inflation. Concerns about the health of China’s real estate sector caused bouts of risk aversion in recent weeks while price pressures and waning central bank support added to equity market uneasiness. The S&P 500 fell by nearly 5% in September, its largest monthly decline since March 2020. The US dollar has been in demand, hitting a year-to-date high in late-September though commodity currencies like the Canadian dollar have held their own against the greenback. We expect the US dollar will see further, modest gains against most major currencies in 2022.

Highlights:

• Central banks are acknowledging inflation will be more persistent than previously expected but there’s little they can do to resolve supply chain bottlenecks and rising energy prices. Most continue to focus on supporting a complete economic recovery.
• The US economy’s strongest gains are likely behind it but the Fed has seen sufficient progress toward full employment to begin tapering asset purchases in November.
• The BoC has emphasized positive labour market data more than disappointing GDP figures. We think it will continue tapering its QE program, switching to reinvestment-only in October.
• The UK labour market continues to improve, giving the BoE more confidence that rates will have to rise modestly in the coming years. But we think the market is pricing in too much tightening following September’s BoE meeting.
• The ECB and RBA will continue with their QE programs in 2022 albeit with the pace of purchases being dialed back. Both are unlikely to raise rates in our forecast horizon.

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Josh Nye is a senior economist at RBC. His focus is on macroeconomic outlook and monetary policy in Canada and the United States. His comments on economic data and policy developments provide valuable insights to clients and colleagues, and are often featured in the media.

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