Central bank watcher: Inflation dominance

Market fears of ‘fiscal dominance’ over monetary policy received a fresh boost recently by developments in the UK. With the U-turn on tax-cut plans, such fears have diminished somewhat. But global bond markets are still on edge.

Meanwhile, concern about high, above-target inflation getting entrenched continues to dominate most central banks’ thinking, except in China and Japan, where underlying inflation pressures remain subdued. Indeed, the PBoC is still in a targeted easing mode, whereas the BoJ continues to resist taking steps towards tighter monetary policy, thus reinforcing the downward pressure on the yen.

By contrast, the Fed seems determined to take the policy rate further into restrictive territory. The ECB is also on track to move to a contractionary rates-policy stance in early 2023. Along the way it is contemplating a retroactive change to the terms of the targeted longer-term refinancing operations (TLTROs) – hopefully without amplifying QE-induced distortions to money markets.

In our view, the onset of gradual QT and economic recession could prompt a halt in the ECB’s hike cycle in spring. By then, the Fed should also be done raising rates. For now, however, fear of entrenched inflation rules.