At the beginning of 2024, all major world central banks were on the same page.
Inflation, which had spiked to 40-year highs in 2022, came down in 2023, and was expected to approach the common central bank target rate of 2% this year. The major world central banks were looking to ease monetary policy, except for the Bank of Japan, which already was easy, having maintained their Negative Interest Rate Policy of the prior 8 years and still executing Quantitative Easing (“QE”).
As 2024 has progressed, however, improvement on inflation has been uneven, and the major world central banks have diverged in executing monetary policies to achieve their goals.
Bank of Canada
Last week, the Bank of Canada (“BOC”) became the first G7 central bank to cut their overnight policy rate. After plateauing at 5.0% since July 2023, the BOC cut their rate by 25 basis points to 4.75%. This was their first rate cut in 4 years.
CPI peaked at 8.1% in July 2022, resulting in a series of 10 rate hikes, which raised the overnight policy rate to 5.0%. These tightening measures have had an impact, causing the CPI to gradually decline. Since the beginning of 2024, CPI has been sub-3%, dropping to 2.7% in April. This is the lowest CPI has been in three years.
Bloomberg
BOC Governor Tiff Macklem, in announcing the rate cut, said:
“if inflation continues to ease, and our confidence that inflation is headed sustainably to the 2% target continues to increase, it is reasonable to expect further cuts to our policy interest rate.”
The BOC has also continued their Balance Sheet Reduction Program, more commonly known as Quantitative Tightening (“QT”). Since peaking at 576.3 billion CAD in 1Q21, they have been able to shrink their balance sheet by 50% to 283.9 billion CAD, its lowest level in 4 years, since immediately pre-pandemic.
Bank of Canada
European Central Bank
Following Canada, the European Central Bank (“ECB”) also cut their Deposit Facility Rate by 25 basis points last week, dropping it to 3.75%.
The ECB represents three additional G7 countries, Germany, France and Italy, as well as 24 other European Member States.
Their Deposit Facility Rate had plateaued at 4.00%, the highest level in ECB history, since September 2023. This represents the ECB’s first interest rate cut since 2019. It is also the first time the ECB has moved rates ahead of the Federal Reserve.
ECB
ECB President Christine Lagarde strongly hinted at the rate cut in April, when the Euro Area CPI printed its second consecutive reading of 2.4%. This showed the substantial progress that has been made on inflation due to the 10 rate hikes, following headline inflation peaking at 10.6% in 3Q22.
Bloomberg
The rate cut was awkward, however, as it came with a few surprises. First, immediately before the ECB meeting, the just released flash headline inflation rate for May jumped to 2.6%. Then, along with the rate cut announcement, the Governing Council said:
“despite the progress over recent quarters, domestic price pressures remain strong as wage growth is elevated, and inflation is likely to stay above target well into next year. The latest Euro system staff projections for both headline and core inflation have been revised up for 2024 and 2025 compared with the March projections. Staff now see headline inflation averaging 2.5% in 2024, 2.2% in 2025 and 1.9% in 2026. For inflation excluding energy and food, staff project an average of 2.8% in 2024, 2.2% in 2025 and 2.0% in 2026.”
ECB policymaker, Robert Holzmann, who was the lone dissenter on the Governing Council to the rate cut, said, “Data-based decisions should be data-based decisions.”
The uptick in inflation, along with the increases in the ECB’s inflation projections over the next two years, give pause to the timing of future rate cuts.
As Christine Lagarde said, “We’ve made the appropriate decision, but it doesn’t mean interest rates are on a linear declining path.”
The ECB has also been reducing its balance sheet through QT. After peaking at €8.84 trillion in 2Q22, the ECB has cut their balance sheet by 25.8% to €6.56 trillion. This represents the lowest level since 3Q22, and also is a 55% retracement of pandemic related QE.
FRED
The Federal Reserve
The Fed has been on a slightly different trajectory this year.
In December 2023, Fed Chair Powell stated that the Fed’s Summary of Economic Projections was looking for inflation to continue its downward movement, and that the Fed would cut its policy rate in three moves by a total of 75 basis points in 2024. Yet as the year progressed, there has been little improvement. Headline PCE is 2.7% and Core PCE is 2.8%
FRED
The balance of risks to inflation is still leaning to the upside. Many economists expect little movement towards the Fed’s 2% target over the remainder of the year, partially because of the comparison to the low inflation figures from the second half of 2023.
In addition, the labor market has remained resilient. The US economy added 272,000 jobs in May, compared to a downwards revised 165,000 jobs in April. The May print was well above the forecasts of 185,000.
BLS
With inflation seemingly stuck at the above target level, and employment remaining solid, many Fed leaders have suggested in public comments over the past few weeks that the Fed is in no rush to cut rates.
The FOMC meets this week, and the expectation is that the Fed will keep their benchmark rate in the range between 5.25% and 5.50%. This will be the Fed’s seventh consecutive meeting of pausing their benchmark rate at its highest level in 23 years.
The Fed will update its Summary of Economic Projections for the first time since March, and the market will be looking for how many rate cuts the Fed is projecting over the remainder of the year. With only 4 more FOMC meetings before year-end, the guessing is between one and two, but there is a slight chance of no cuts before 2025.
A small minority, like Minneapolis Fed president Neel Kashkari, a non-voting FOMC member, won’t rule out a rate hike.
As for the less public portion of its monetary policy, the Fed has also made significant progress with its QT. After peaking at just under $9 trillion in 2Q22, the Fed has reduced the size of its balance sheet to $7.25 trillion. This represents $1.7 trillion in QT, or a 19% reduction. Total assets at the Fed now stand at the lowest level since December 2020. They also represent a 36% reduction of the pandemic related asset growth due to QE.
FRED
Starting this month, the Fed is tapering their Treasury security runoffs, so the pace of QT will slow. The Fed will now have a $25 billion per month cap in Treasury security runoffs, down from the $60 billion per month cap of the past 18 months.
Bank of Japan
Japan has been the outlier among the G7 nations. Over the past two years, while other central banks were raising rates to fight inflation, the Bank of Japan (“BOJ”) maintained an easy money policy. They, too, experienced a spike in inflation, but they did not change policy to battle it.
Until this year.
In March, the BOJ reversed eight years of Negative Interest Rates and raised its policy rate from the range of between -0.1% and 0.0% to the range of between 0.0% and 0.1%.
Bank of Japan
While this was their first tightening move, there is still a wide yield gap between the BOJ and other major world central banks. Due to these yield differentials, bond yields have risen, and the yen has weakened.
For a detailed analysis, please see my recent Seeking Alpha article, “Japanese Government Bond Yields At 13-Year high, While Yen At 34-Year Low.”
Despite the March tightening, however, the market is clamoring for more tightening, to narrow the yield gap.
The BOJ meets this week, and there is a chance that they will tighten policy again with another rate hike, although a hike in July is more likely.
The BOJ is also looking to pare back their asset purchases. For the past two years, while other central banks have been executing QT to shrink their balance sheets, the BOJ has continued with its QE policy with regularly scheduled asset purchases.
As a result, the BOJ’s balance sheet stands at an all-time high of ¥761 trillion.
FRED
In May, BOJ Governor Kazuo Ueda said:
“It is appropriate for the Bank to reduce the amount of JGB purchases as it proceeds with its exit from large-scale monetary easing.”
At this week’s BOJ meeting, it is expected that they will discuss cutting their monthly bond purchases. Currently, the BOJ is buying ¥6 trillion per month of Japanese Government Bonds (JGBs.) If a reduction in bond purchases is enacted, the BOJ will actually be implementing a de facto QT policy because they are experiencing roughly ¥5.8 trillion per month in JGB maturities.
Through buying fewer JGBs than are maturing each month, the BOJ will begin reducing their balance sheet, or begin executing QT.
Bank of England
The Bank of England (“BOE”) Monetary Policy Committee raised interest rates to a 16-year high of 5.25% last August to combat inflation, and has held them there ever since.
BOE
Despite the aggressive monetary tightening, the inflation rate has remained stubbornly high, well above the target rate of 2%. Core CPI (ex-food and energy) was 3.9% in April.
FRED
Service inflation was even higher in April, at 5.9%.
In addition, there is uncertainty on the labor front, with strong wage growth at 6%, even with unemployment climbing to 4.3%, its highest level in almost a year.
Considering this backdrop, when the Monetary Policy Committee meets on June 20th, the expectation is that they will again hold rates at the current level. Despite the general election looming on July 4th, the higher-than-expected underlying inflation extinguished any hopes for a pre-election rate cut.
The BOE has been continuing with their balance sheet reduction through QT. After their bond holdings peaked at £895 billion, they now stand at £700 billion, a 22% cut.
Office For National Statistics
The BOE is the first central bank to implement QT through asset sales, instead of maturity runoffs. Although, they have incurred large losses in their bond sales, these have been offset by the Treasury through an indemnity agreement. This cost is ultimately borne by the taxpayer.
Conclusion
While at the beginning of 2024 the major central banks of the world were all on the same page in expecting inflation to hit their target of 2%, which would allow them to reduce their policy rates, the unevenness of their inflation paths has caused their monetary policies to diverge.
The Bank of Canada and the ECB, which together represent 4 of the G7 nations, went through with one rate cut each this year. Another two G7 central banks, the Fed and the BOE, have held off on easing policy because of the stickiness they have experienced in their fight to bring inflation down. And the final G7 central bank, the Bank of Japan, has gone in the opposite direction, and raised rates, to experience their first step into tightening monetary policy after so many years of easy money.
The BOC and the ECB are experiencing their own internal conflict with their monetary policy, as they are easing by cutting rates, while at the same time they are tightening by continuing their QT policies.
This is an unusual period where we have such wide divergence in the major world central banks’ execution of their monetary policy as they all try to achieve the same goal of 2% inflation.
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