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ECONOMY|03.21.2024

Japan ups rates, ushering in new scenario for central banks

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Monetary policy is, once again, capturing the headlines in economic news, with the U.S. Federal Reserve (Fed), the Bank of England (BoE) and the Bank of Japan (BoJ) all meeting to review their situations.

Uncharacteristically, it was the BoJ that surprised everyone though: after more than 17 years without raising interest rates and a decade with the price of money negative, it finally decided to raise rates from -0.1% to 0.1%, opening a new chapter in the country’s monetary policy.

“They’ve had an accommodative monetary policy for almost 20 years, the most relaxed in the world. However, the spirit remains unchanged: they still want to be accommodative. They’ll continue with the rate hike process, but in a smooth fashion,” explains Alberto Matellán, chief economist at MAPFRE Inversión.

MAPFRE Economics, MAPFRE’s research arm, adds that the BoJ also seems intent on ending control of the yield curve and the purchase of indexed funds (ETFs), which were facing stock market exposure, and J-REITS, which gave it exposure to the real estate sector. It wouldn’t be ending quantitative easing entirely though, just not adding any new purchases. “The BoJ hasn’t said that it’s going to get rid of positions, but rather it’s going to stop buying more,” the research team clarified.

For its part, the Fed decided to keep official interest rates in the range of 5.25% – 5.5%, in line with what the market expected, and introduced the discussion of slowing down balance sheet reduction in the near future. At macro level, the new forecasts showed a higher growth outlook, highlighting the increase to 2.1% for this year compared to the previous 1.3%. The labor market was also forecast to perform better, with unemployment at between one or two tenths over current levels, while inflation forecasts remain virtually unchanged, although slightly corrected upward.

MAPFRE Economics explained that the Federal Open Market Committee (FOMC), the branch of the central bank that makes monetary policy decisions, seems willing to lower rates in the coming months if sufficient evidence for doing so is observed. But they aren’t ready to move on that yet, hence the current preventive time-out. This position allows them to continue gaining confidence in the chosen path and partially recover the credibility lost by not clearly defining a predictable pace of action.

“There has been a very sharp change in market perception, also due to growth, which is better than expected and that’s what’s marking the Fed’s road map. With the macro figures alone, lowering rates wouldn’t be justified with growth expectations of more than 2% and no forecast of returning to target until 2026,” adds Matellán.

In addition, MAPFRE Economics noted that the country’s latest inflation data show some stagnation in disinflation, hand in hand with an increase in energy prices, commodity prices, service prices, which remain high, and more rigid housing inflation.

June seems to be the most likely date to start the process of easing, but, again, very cautiously, passively and with room to disappoint in the sense of a scenario with fewer cuts, given the greater inclination toward dynamic activity and employment, stagnation in inflation above the target, a public deficit setting records and the same forces of change in global geopolitics that have led Japan to take the first step toward monetary normalization for the first time in almost two decades,” added MAPFRE Economics.

The latest monetary policy meeting was held by the BoE, which also decided to keep rates at 5.25%. This case is more complicated than that of the European Central Bank (ECB) because UK’s macroeconomic situation is worse, considering that its inflation is also different from that of the EU, more guided by energy prices, or that of the United States, which is fueled by service prices. “In the United Kingdom, intrinsic inflation is very strong, and that means the central bank’s hands are pretty much tied,” explains Matellán.

MAPFRE Economics explains that the UK’s central bank showed a more flexible position compared to its previous meeting to the extent that “things are moving in the right direction.” It added that “this is a positive sign for the future, but the data support an even more cautious position than the ECB or the Fed and justify staying one step behind in terms of decision-making.”

 

What did the ECB do in March?

At its meeting on March 7, the ECB held interest rates for the fourth consecutive time at 4.75% for marginal lending, 4.50% for the main financing rate and 4.00% for the deposit facility. It also revised both inflation and economic activity in the eurozone downward, the latter to a lesser extent.

Europe is currently experiencing a macroeconomic situation that is different from the United States, with weaker growth, but which is gradually improving. As such, the ECB emphasized that rate cuts are still premature and that to do so wouldn’t be “a rational decision, or compatible with the current state of the economy,” according to MAPFRE Economics.

It seems that the ECB is taking a more balanced approach in the short term, although without specifying imminent movements. In any case, the central assumption of the market seems to be that conditions will be set for a cut in June, synchronized with the Fed.