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DM central banks holding firm while acknowledging improved growth prospects

Daniel Richards - MENA Economist
Published Date: 30 June 2021


Halfway through the year, and the growth prospects for the big developed markets have largely improved since January, with the Federal Reserve, ECB and BoE all significantly upgrading their growth projections in recent weeks. Japan is the outlier, where the April forecast review saw the bank’s 2021 forecast raised by just 0.1 percentage points, and the mid-June MPC statement cautioned about residual Covid-19 risks to the outlook. As has been the case since last February, the pandemic will remain the key determinant of economic performance over the remainder of the year. As such, its ebbs and flows will also play a key role in informing any tightening of monetary policy, with new variants of the disease of particular concern. The US, which is further down the road in its recovery and is facing more acute inflationary pressures – however transitory – will likely be the first to start paring back monetary support, with the others likely to wait and take their cue from the Fed.

Growth projections upgraded as vaccinations pick up

The US, Eurozone and UK have all enjoyed effective vaccination rollouts which have enabled them to push ahead with economic reopening and the lifting of restrictions on movement and activity since the start of the year. Bolstered by highly accommodative fiscal and monetary policy, they have seen a major boost in output in recent months. Initially this was concentrated in booming retail sales but as hospitality outlets have reopened these have now taken the lead, as evidenced by a recovery in restaurant bookings to pre-pandemic levels for the first time. In Japan, however, the vaccination rollout has been slow with only around 10% of residents vaccinated and it looks set to be the laggard amongst the world’s biggest economies.

Net change in Covid-19 cases, 7dma '000

Source: Bloomberg, Emirates NBD Research

In the first quarter it was very much the US that was leading the DM recovery as its vaccination programme took off and case numbers fell, enabling the country to loosen restrictions earlier than its European counterparts. First quarter growth in the US came in at 6.4% q/q on an annualised basis and at its June meeting the FOMC upgraded its 2021 growth forecast from 6.5% to 7.0%. By contrast, Q1 saw the reimposition and strengthening of restrictions in the UK and Eurozone and the two economies contracted in the first quarter, at -1.5% q/q and -0.3% q/q respectively. Nevertheless, since then the gap has narrowed, and UK monthly GDP figures and other data point towards a robust second quarter, prompting the BoE to upgrade its growth projection for Q2 by 1.5 pp since the May report, taking it to 5.5%. In Europe, the ECB now forecasts full year growth of 4.6% in 2021, compared to its May projection of 4.0%.

Provided the signposted re-openings are not further derailed by new variants of the disease, the prospect for the second half of the year is bright. All the same, this risk cannot be discounted, with the UK having already pushed back the last part of its reopening as case numbers have risen once again, and German Chancellor Angela Merkel has been pushing for Eurozone-wide action to contain the risk of the Delta variant spreading.

Real GDP growth, % y/y

Source: Bloomberg consensus forecasts, Emirates NBD Research

DM central banks maintaining loose stance despite ameliorating outlook

With the threat of these new variants salient the central banks have remained cautious and reluctant to pull the rug out from under any nascent recovery by tightening monetary policy too early, even while acknowledging a rapidly improving outlook and price growth that has hit multi-year highs. Despite the odd inflation hawk on all three committees, the Fed, ECB and BoE are all largely maintaining the party line that the recent inflationary pressures are transitory and will fade as the reopening disruption eases. Furthermore, an increased focus on the labour front, especially by the Fed, makes any sharp action unlikely for now while there remain high levels of unemployment, even as job openings surge. In the US the outlook has been improving, but there remain 7.6mn fewer people in employment than there were prior to the pandemic (despite openings at over 9mn), and jobs data has been repeatedly missing expectations. Equally in the UK the picture remains fairly cloudy so long as the government’s furlough scheme remains in play, and the BoE cited uncertainty around the prospect of discouraged workers returning to the market when this ends.

Central bank assets, rebased to Jan 2020

Source: Bloomberg, Emirates NBD Research

Of the three, the US has arguably taken the most hawkish turn in the latest round of meetings, but this is by degrees. The dot plot of FOMC member projections for when rates would start to rise did come forward from where it was previously, with a majority of members now expecting two rate hikes in 2023 rather than beyond the forecast period in 2024 or later as had previously been the case. However, while chair Jerome Powell said that the board was ‘talking about talking about’ tapering its asset purchases, he also stressed that reaching 'substantial further progress is still a ways off’. This will remain dependent on the coming months’ data, with some evidence in recent prints that there has been some recovery fatigue in the US. We would anticipate that any rollback of QE won’t begin until the start of 2022, with the first, cautious, rate hike likely to follow a year or so later in Q1 2023.

With regards to the UK, the June meeting also kept its loose policy in place, with the language in the communiqué retaining its dovish slant, stating that the MPC ‘does not intend to tighten monetary policy at least until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% inflation target sustainably.’ This is perhaps unsurprising given the questions in place around the UK’s recovery on the back of the rapid spread of the seemingly more contagious Delta variant of Covid-19 in recent months. This has prompted the government to push back its June 21 reopening date by a month and is hampering any return to normalcy in international travel. Even the seemingly hot-running housing market was simply described as ‘strong’ by the bank’s statement, and with the departure of chief economist Andy Haldane at the end of June the nine-member MPC has lost its only dissenting, hawkish, voice.

Benchmark rates (%) at historic lows

Source: Bloomberg, Emirates NBD Research

The ECB also maintained its ultra-loose policy at its June meeting, with President Christine Lagarde seeing the risks as ‘broadly balanced’, with the bank’s more optimistic growth outlook tempered by residual uncertainties around the pandemic. A host of indicators including Google mobility data and PMI surveys, alongside falling Covid-19 infection rates, signal upside risk to the growth outlook in the Eurozone, but the ongoing risks meant that an ‘ample degree of economic accommodation’ was still warranted. Lagarde did acknowledge that the improving outlook could see a policy adjustment sooner than anticipated, but we believe it is unlikely to make the first move in any tightening, with the Fed’s move likely to be the one to get the ball rolling.

Emerging markets will lead the global tightening

While the prospect of tighter DM monetary policy is becoming ever closer, it is worth bearing in mind that this by no means heralds a rapid return of tight conditions in developed markets. Policy has been extraordinarily loose since the start of the pandemic, with benchmark interest rates cut back to record lows and massive boosts to QE programmes, and the rollback of this is unlikely to be overly eager as policymakers wish to ensure a stronger and more durable recovery compared to that which followed the global financial crisis. When the eventual tightening does begin, it will be slow and cautious, with a focus on supporting the ‘build back better’ mantra.

Even so, some of the more exposed emerging markets will be watching any shift in stance closely, and those countries where the growth outlook is even more uncertain are set to be at the vanguard of the global tightening. While the major DM central banks were only acknowledging the prospect of discussing tightening policy in June – and this will almost certainly come in the form of cutting back on QE rather than raising rates initially – there were actual rate hikes in Mexico, Hungary and Brazil this month. Those EM countries such as Philippines which opted to maintain accommodative stances have seen their currencies slip, evidence that developing economies enjoy less leeway in supporting their economic recoveries.