Central bank sentiment

Central banks are dealing with difficult conditions in 2021. Almost uniformly, they face economies that are growing and prices that are inflating rapidly, while they need also to maintain extraordinarily loose monetary policy to guarantee long-term economic recovery.

Most central banks have moved away from their most dovish positioning of 2020, acknowledging the improving path of economies compared with a year ago. Some, such as the Reserve Bank of New Zealand and Bank of Canada, have taken significant steps toward unwinding stimulus in response to local inflation and growth indicators. But most remain committed to maintaining asset-purchase programmes and ultra-low rates until inflation is clearly sustained.

US Federal Reserve (Fed) chair, Jerome Powell, caused something of a stir in global markets late in 2020 when he suggested that inflation could be allowed to run beyond the Fed’s target levels in the aftermath of COVID-19 to ensure economic recovery was in full swing before beginning a tightening cycle.

This sentiment, in more or less explicit terms, has become consistent across central banks in most major economies and has stayed in place even as inflation data has printed consistently strong results in recent months.

Some global reserve banks have brought forward interest-rate hiking expectations or asset-purchase tapering. On the other hand, all are still patiently waiting to see sustained rather than transitory inflation before making a significant move.

In July, following a particularly strong consumer price index print in the US, Powell said in testimony to the US Senate: “Inflation has increased notably and will likely remain elevated in coming months before moderating. Inflation is being temporarily boosted by base effects, as the sharp pandemic-related price declines from last spring drop out of the 12-month calculation.”

He continued: “In addition, strong demand in sectors where production bottlenecks or other supply constraints have limited production has led to especially rapid price increases for some goods and services, which should partially reverse as the effects of the bottlenecks unwind.” 

In the Federal Open Market Committee’s July monetary-policy report, long-run inflation expectations were still only 2 per cent – unchanged from its March report.

Meanwhile, Michael Saunders, a member of the Bank of England (BoE)’s monetary policy committee, said in a speech on 15 July that there is now clear evidence in the UK of “significant progress being made in eliminating spare capacity and achieving the 2 per cent inflation target sustainably” – a precursor for BoE tightening.

However, at the BoE’s August monetary-policy report, the committee maintained its interest-rate and QE settings, explaining that it expects above-target inflation to be temporary.

The European Central Bank (ECB) also remains pessimistic on the inflation outlook and maintains ultra-loose policy settings.

ECB president, Christine Lagarde, said in her July monetary-policy statement: “There is still some way to go before the fallout from the pandemic on inflation is eliminated. As the economy recovers, supported by our monetary-policy measures, we expect inflation to rise over the medium term, although remaining below our target. While measures of longer-term inflation expectations have increased, they remain some distance from our 2 per cent target.”