The monetary policy decisions of major central banks have continued to be a focus of economic analysis in recent months. In particular, the US Fed increased its target rate by 100 basis points (bps) in 2018, 25 bps more than expectations earlier in the year, mainly as a result of the additional impulse to economic activity provided by the government’s fiscal stimulus. However, concerns have emerged that the pace of monetary tightening could result in a faster-than-anticipated slowdown in the US economy in 2019. Indeed, the spread between the yield of short- (2 years) and longterm (10 years) treasuries has declined considerably, signalling some economic deceleration going forward.
Furthermore, no major acceleration in US inflation has been observed, despite persistent and robust labour market improvements in recent years. Inflation stands around the Fed’s 2% target, with readings likely to remain restrained in the coming months. Fed policy makers, recognizing the downside risk for the economic outlook, decreased their median expectation of interest rate increases for 2019 to 50 bps at their last meeting, from their previous estimation of 75 bps.
The central banks of the other major developed economies began monetary tightening last year, although the path forward remains uncertain. In the Euro-zone, the ECB stopped asset purchases in December, but with inflation readings still subdued, and given a significant deceleration in core Euro-zone economies in 2H18, market participants have cast doubt on a potential 2019 rate hike. Uncertainties related to Brexit and budget disputes would also likely result in additional ECB caution. The Bank of England (BoE) increased interest rates by 25 bps last year, and the possibility of further tightening is contingent on the Brexit outcome. Meanwhile, the Bank of Japan (BoJ) signalled during 2018 that it expects to keep its monetary stimulus programme in place, with inflation rates much below the target and an ongoing subdued economic outlook
In 2018, the increasingly divergent central bank monetary policies resulted in a strengthening US dollar, particularly against currencies of emerging economies that face large current account deficits. This has forced some of their central banks to tighten monetary policy in order to stem capital outflows. For example, Argentina and Turkey, were forced to sharply increase interest rates and, in the case of Argentina, seek the support of the International Monetary Fund. The Reserve Bank of India (RBI) increased its main policy rate twice last year on surging inflation and a weakness in the Indian rupee. However, pressure on the currency moderated in 4Q18, providing more room for the RBI to remain accommodative. In the case of China, the People’s Bank of China (PBoC) reduced the ratio of required reserves three times in 2018, in an effort to support the economy. In early January 2019, the bank announced an additional cut, with further cuts to bank reserve requirements likely to be implemented during the year to spur bank lending.
While the economic risk remains skewed to the downside, the likelihood of a moderation in monetary tightening is expected to slow the decelerating economic growth trend in 2019. This has recently been reflected in global financial markets with asset prices recovering somewhat from the low levels seen at the end of 2018. The positive effect on market sentiment was also witnessed in the oil market. If the anticipated moderation in monetary policies coupled with an improvement in financial markets materializes, this could provide further support to ongoing increases in non-OPEC supply. Therefore, the ongoing collaboration between OPEC and non-OPEC producing countries participating in the ‘Declaration of Cooperation’ remains essential in helping to maintain balance in the oil market.
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