Led by the Federal Reserve, many developed-nation central banks are starting to pivot away from the emergency rates spurred by the 2008 crisis, the oil price crash and geopolitical shocks like the Brexit vote.
But how far and how fast will central banks raise rates? As they move up from emergency levels, most don’t even know.
“Part of the central bank journey is one of experimentation, ultimately probing for the right level of interest rates that will not compromise economic growth that is already challenged by aging demographics,” TD says in an economics note on Thursday.
It adds, “For the U.S., we believe [the Fed] has comfortably moved from the lift-off phase to the probing phase. Following four rate hikes and soon-to-be execution of balance sheet run-off, the Fed has far less runway in its rate-adjustment cycle than other countries.”
One risk for central banks is whether inflation targets can be met amid structural factors weighing on price growth. Aging demographics and online shopping, for instance, have emerged as structural drags on prices.
Advanced economies have not been able to sustain inflation near their targets since the financial crisis, TD says, noting that even central banks admit that post-crisis inflation dynamics are not entirely understood.
But central banks in developed nations are pursuing a pivot toward higher rates — and there’s room to go.
The BoC’s 25 basis-point hike in July was seen as “an abrupt U-turn from the Bank’s previously cautious communications focused around weak inflation and trade threats,” the TD note says, while, in Europe, the ECB “has also taken a few steps back from prior dovish sentiment to do ‘whatever it takes’ to support economic activity.”
The BoE is also considering a hike, just one year after the Brexit process started, say the TD economists.
While the Fed has moved from liftoff to economic probing, the BoC, the BoE and ECB “are just starting or are preparing for lift-off,” TD says. In other words, many central banks have some distance to go before they get into the economic probing zone, so be ready for more surprises from the BoC and central banks other than the Fed.
In the U.K. and Europe, for instance, expect “forward guidance of less monetary easing later this year and potentially hikes in 2018,” says TD. In Canada, be ready for more rate hikes this year and next, the TD economists say.
“Outside the U.S.,” they add, “the lift-off stage has quite some time left to run as there is significant space between real policy rates and the level of real rates that would start to choke off growth.”