Inflation is still ongoing, risks remain, and global monetary policy divergence is intensifying

Reporter Qian Boyan

Global central bank monetary policy should tend to be coordinated and closely coordinated, but the current challenges facing economies are very different, and monetary policy divergence is intensifying.

On June 20, the Swiss National Bank and the Bank of England announced their latest interest rate decisions. After becoming the first advanced economy to start an interest rate cut cycle in March, the SNB announced another 25 basis points cut its benchmark interest rate to 1.25%; The Bank of England decided to keep its benchmark interest rate high at 5.25%.

The SNB believes that underlying inflationary pressures have fallen again compared to the previous quarter. With the policy rate lowering, the SNB was able to maintain appropriate monetary conditions. In May, Switzerland's consumer price index (CPI) rose 1.4% year-on-year, unchanged from April. The SNB forecasts an average annual inflation rate of 1.3% in 2024, 1.1% in 2025 and 1.0% in 2026.

The Bank of England said monetary policy still needs to remain restrictive for a long enough time. In May, UK CPI rose at an annualized rate of 2.0%, 0.3 percentage points slower than in April, returning to the central bank's 2% inflation target for the first time in three years. However, core inflation, which excludes energy, food, alcohol and tobacco, is at 3.5%, and the BoE's closely watched services inflation of 5.7% remains elevated.

The divergence in monetary policy is also reflected in other advanced economies, most notably the fact that interest rates in the United States and the eurozone are no longer in sync.

On 6 June, the European Central Bank (ECB) announced a 25bp cut in each of the three key interest rates in the eurozone, with the deposit facility rate directly related to consumers falling to 3.75%. On 12 June, the Fed announced that it would keep the target range for the federal funds rate unchanged at 5.25%-5.5%, and the interest rate differential between the United States and Europe widened further.

At present, the mainstream judgment of the market is that the Fed will cut interest rates only once this year, instead of the six expected at the beginning of the year, with a range of 25 basis points; The ECB is expected to cut interest rates twice more this year, with a cumulative range of around 40 basis points.

In addition, the Bank of Japan announced a 10 basis point interest rate hike in March this year, raising the key interest rate to around 0%-0.1%, which is the first rate hike in Japan since 2007 and marks the exit of the eight-year-old era of negative interest rates. The market expects Japan to raise interest rates twice more this year, with a cumulative range of around 40 basis points.

Song Xuetao, an analyst at Tianfeng Securities, used the term "siege" to describe the challenges faced by major central banks: the United States envies the continued slowdown of inflation in Japan and Europe, while Japan and Europe covet the steady growth of the US economy, and the United Kingdom is facing the challenge of continued "stagflation", and their respective monetary policies are facing different constraints. In general, the current monetary policy forks of global central banks are still in response to the different inflation trends of their respective economies.

Zhang Ming, deputy director of the Institute of Finance and Economics of the Chinese Academy of Social Sciences and deputy director of the National Finance and Development Laboratory, believes that the current economic growth rate in the euro area is not as fast as that of the United States, the inflation rate is lower than that of the United States, and the unemployment rate is higher than that of the United States. Considering that the monetary policy goals of the European Central Bank and the Federal Reserve are to keep the core CPI growth rate at about 2% year-on-year, the ECB's demand and urgency to stabilize economic growth by cutting interest rates is stronger than that of the United States.

In April, the International Monetary Fund (IMF) adopted "Resilience in the Face of Divergence" as the theme of its latest Global Economic Prospects report. In the report, the IMF expects the US economy to grow by 2.7 percent this year, 0.2 percentage points higher than last year and 1.9 percent next year. At the same time, the IMF expects the eurozone to grow by 0.8% this year and 1.5% next year, respectively, up from 0.4% in 2023, but not as strong as the US economy.

From the perspective of inflation, in May, the US consumer price index (CPI) and core CPI grew by 3.3% and 3.4% year-on-year, respectively, significantly higher than the CPI and core CPI growth rates of 2.6% and 2.9% in the euro area during the same period.

Central banks in other advanced economies are also in a tricky situation. For example, Japan is facing increasing pressure on the depreciation of the yen, imported inflationary pressure due to depreciation, and uncertainty about economic recovery. Switzerland is under pressure from the Swiss franc to appreciate against the euro, leading to a decline in the price of goods imported from eurozone neighbours, putting downward pressure on Swiss prices as a whole and increasing pressure on export-focused Swiss industry. In addition to high inflation, the UK is also facing rising unemployment, weak recovery of industrial production, and slow credit expansion, and in a more obvious "stagflationary" environment, it is believed that the Bank of England should cut interest rates decisively to maintain the momentum of economic recovery and avoid a second recession.

Chris Giles, an honorary professor at University College London, wrote in the Financial Times that for smaller emerging economies, the central banks of these countries will choose to follow the Fed and formulate monetary policies that are not suitable for their own economies because changes in interest rates in the United States will cause capital outflows. But the eurozone is different, because of its huge economic size, it can clearly set its own monetary policy.

But the ECB is dismissive. Robert Holzmann, the head of the Austrian central bank, said: "If the Fed doesn't cut rates this year, it's hard for me to imagine that we'll cut rates three or four times. Croatian Central Bank Governor Boris Vujcic also said: "The longer we have [interest rate differentials] with the Fed, the greater the impact is likely to be." ”

Mohammed Erian, chief economic adviser of Allianz, believes that the divergence in the path of interest rates between the two largest economies in Europe and the United States will have a huge impact on the economies of both countries. A weak euro will not only bring imported inflation, making it more difficult for the ECB to control inflation, but also increase the competitiveness of European products in export markets, coupled with the reshaping of global supply chains led by the United States, and may strengthen the country's protectionist tendencies in an election year.

For China, Zhang Ming said that the divergence of monetary policies between Europe and the United States and the structural characteristics behind them could have a potential impact on the Chinese economy. First, the resilience of the U.S. economy and the improvement in the growth rate of the eurozone economy mean that external demand in China's export industry will remain positive. Second, monetary policy will be eased in major advanced economies in the second half of this year, which means that the short-term capital flow pattern facing China is expected to improve further. In fact, in the first half of this year, China's balance of payments portfolio investment ushered in a re-inflow of short-term foreign capital. Third, as the Fed may enter a cycle of interest rate cuts around September, the US long-term interest rate and the US dollar index are both expected to fall, which means that the RMB exchange rate against the US dollar will stabilize or even rebound.