Comments from US Federal Reserve Chair Jerome Powell supported the market narrative that central banks are on the path to quickly returning policy toward neutral settings, even as headwinds to global growth are intensifying. Volatility in the fixed income markets remains high with implications for equities while strength in the US dollar index has extended to be trading around 2-year highs.
IMF downgrades global growth, upgrades inflation outlook
The IMF this week outlined the increasingly complex economic outlook that has unfolded following the Ukraine war, with rising inflation pressures intensifying the headwinds to growth. For policymakers, this outlook has exacerbated the trade-off between needing to stabilise inflation while at the same time safeguarding growth prospects. Forecasts for global GDP growth have been lowered this year from 4.4% to 3.6% and in 2023 from 3.8% to 3.6%, with the Russian invasion of Ukraine, the withdrawal of monetary and fiscal support, a slowdown in China and the ongoing effects of the pandemic the factors cited as driving the downward revisions. At the same time, with the war adding to existing supply-driven inflation pressures through higher commodity, energy and food prices, forecast inflation in 2022 for advanced economies was lifted from 3.9% to 5.7%, and from 2.1% to 2.5% in 2023.
The largest 2022 growth downgrades were in Russia and Ukraine stemming from the direct impacts of the conflict, while the spillover effects on supply chains and energy prices have dented growth prospects in the euro area (3.9% to 2.8%), particularly in Germany and Italy due to their significant manufacturing sectors. With the Fed hiking rates and the Congress unable to agree on the passage of fiscal stimulus, forecast US growth in 2022 was cut from 4% to 3.7%. With China persisting with its zero-Covid approach, the associated lockdowns and restrictions have seen its growth outlook fall from 4.8% to 4.4%. Against the run of play, Australia was one of the few major economies to receive a growth upgrade, with the 2022 forecast lifted from 4.1% to 4.2%.
RBA minutes detailed the Board's hawkish pivot
The hawkish pivot from the RBA to remove its patient guidance came about due to the likely timing of the first rate hike being "brought forward" with inflation pressures rising and wages growth firming according to the April meeting minutes. Markets expect the cash rate to start rising in June, though they are giving some chance of liftoff in May and that could firm if next week's Q1 CPI data comes in stronger than expected (1.7%q/q, 4.6%Y/Y). Factors that will be key throughout the RBA's hiking cycle will be the evolution of price and wage pressures, with the former largely being driven by supply constraints and the latter picking up but yet to reach levels consistent with sustainable 2-3% inflation. The minutes also revealed international developments will also be influential. The observations from the Board were that tightening expectations had become more frontloaded but that policy rates were likely to peak lower than in previous cycles due to the risks to the downside risks to the global growth outlook.
Fed Chair Powell endorses faster tightening
During an IMF panel discussion, US Fed Chair Jerome Powell made clear his intent was to step up the pace of monetary policy tightening to counter high inflation saying that it was "...absolutely essential to restore price stability". The key message Chair Powell wanted to get across was that the FOMC will be moving "expeditiously" in returning the policy rate to a more neutral level by the end of the year. This validated market expectations for a larger 50bps hike in May, which is expected to be followed up by two further 50bps hikes in June and July. Given the current inflation pressures, Chair Powell said it was appropriate to be removing accommodation more quickly than in the past, though there was recognition of the challenge the Fed is facing in trying to deliver a soft landing. For the time being, the strength of the US economy and tight labour market is giving the FOMC confidence that it can withstand substantial monetary policy tightening.
Caution marks the outlook in Europe...
Compared to the US, the euro area economy is in a more fragile position, highlighted by the IMF growth downgrades, while also facing significant inflation pressures. The IMF panel discussion was also attended by ECB President Christine Lagarde who was more cautious in her outlook for policy saying that the supply shock-driven rise in inflation called for a gradual and sequential response. President Lagarde also noted that although headline inflation was 7.4%yr in March, the core rate was 2.9%yr (both readings were revised 0.1ppt lower this week), a more manageable situation than in the US. However, markets picked up on the hawkish shift from ECB Vice-President de Guindos who called for asset purchases to be brought to an end in July, opening the door for rates to start rising from then onwards.
... and increasingly in the UK as well
Bank of England Governor Andrew Bailey spoke of the fine line the MPC was treading in hiking rates to bring down inflation at the same time as growth prospects were coming under pressure from the negative shock to real incomes. MPC member Catherine Mann said in a speech this week that the evolution of the BoE's hiking cycle hinges on the responsiveness of consumer demand to the surge in inflation. The early indications are that the impacts are material as retail sales volumes came in much weaker than expected falling by 1.4% in March as consumer confidence deteriorated to its lowest since 2008.