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Tightening already in sight

In less than 18 months the global economy has shifted from the depths of a very deep pandemic-induced recession to the point where reduction in policy stimulus has started.

The Reserve Bank of New Zealand has begun scaling back its quantitative easing (QE) purchases and the RBA adjust its liquidity programs. ANZ Research expects the US Fed to signal tapering in August.

Rate hikes are likely in 2022 from New Zealand, South Korea, India, Indonesia, Malaysia, Philippines, Vietnam and the UK, and in 2023 from the US, Australia and Thailand. The risk on these timelines is that they have tended to be brought forward.

Central bank tightening cycles are typically associated with yield curves peaking, and showing some flattening trends over time. COVID-19 remains a meaningful influence on the outlook, but for most economies its actual impact on economic activity has diminished substantially as the pandemic has worn on.

ANZ Research’s growth forecasts, as a consequence, have changed only modestly from the March quarter, despite renewed outbreaks in a number of economies. Movement restrictions simply haven’t tightened the way they did through the early stages of the pandemic. The restricted activities are often just not that important from a macroeconomic perspective.

In many economies there is much less caution when outbreaks do occur. Even in India the recent rise in cases caused only  a very modest decline in business sentiment.


The policy response remains very strong and has helped drive activity in some sectors to well above pre-COVID levels. Central banks haven’t raised rates yet despite the speed of the global recovery, and the IMF’s estimate of the fiscal stimulus has doubled over the last year to 19 per cent of global GDP.

Reflecting these influences, the experience of India this year, along with the UK and US in 2020, shows that the impact of COVID-19 on risky asset prices has faded. As such, for most economies, COVID-19 is a key risk for particular sectors rather than a general macroeconomic risk.

COVID-19 can pose a key macroeconomic risk, but mainly for middle- and lower-income economies where the policy response might be more constrained. This includes Thailand, the Philippines and Malaysia. As tightening, particularly by the US Federal Reserve, approaches, the flow-on effects will increasingly be a focus.

Although the reduction in liquidity will affect some asset prices, a replay of 2013’s taper tantrum is unlikely. One important difference from the post-GFC global recovery is that the US is leading this global cycle, rather than China.

Part of this reflects policy base effects. China was easing earlier, so the rate of change will slow earlier. But it also reflects less forceful policy follow-through in China. This leaves emerging markets and other risky asset prices better placed to cope with US tightening.


What has changed for the worse is the duration of the COVID-19 crisis. It’s become clear vaccine distribution is complicated and becomes more difficult as the number of distributed doses rises. The available vaccines could reduce COVID-19 to a manageable health problem, but fully opened international travel seems some way off for most countries.

Tourism destinations, often lower- and middle-income economies, will feel the economic cost of closed borders most acutely; while, for many high income economies, the primary impact will be a reduced labour supply and thereby higher inflation.

Inflation, rather than growth, is the primary focus for financial markets, and there remains meaningful debate about the outlook. Even in economies that have recovered smartly and where labour shortages have emerged, there is still a question about the degree to which the dampened inflationary outcomes of the last cycle are a template for the current cycle. In ANZ Research’s estimation, they are not.

Factors such as technology, demographics and debt continue to exert a deflationary drag, but the specifics of this cycle suggest to us a sustained rise in inflation is likely to be occurring.

ANZ Research has revised its inflation forecasts higher across both 2021 and 2022. This recovery doesn’t have the balance sheet headwinds that were present after the GFC. In fact, banks in many economies have excess capital and are keen to lend, capacity use is rising and is back to pre-GFC levels in some economies, fiscal orthodoxy has shifted such that fiscal policy is still stimulatory even as economic cycles mature, and the US Fed has shifted to its most permissive stance since the 1970s.

The structure of consumer demand is also likely to become more inflationary over time. The economies leading the global recovery, including the US, China, UK, Australia and New Zealand, are doing so with spending on goods elevated and spending on services repressed relative to pre-COVID levels.


Borders progressively opening and immigration returning is likely to add to labour supply. But there is also likely to be a shift to services consumption, which is likely to be inflationary. Services are more labour intensive than goods, and productivity improvements are harder to find.

Much of the inflation narrative is focussed on wages, but inflation is not just a wage story. Commodity prices are also a relevant influence. Inflation expectations are likely to be more sensitive if both commodity and wage inflation are in evidence, and businesses are likely to find it more difficult to absorb broad-based cost increases.

Pre-GFC, the last time there was a broadbased central bank tightening cycle, commodity prices were rising strongly. In ANZ Research’s view, the commodity spectrum is being impacted by a range of forces which are likely to keep prices high.

The shift in fiscal orthodoxy and the Fed’s mandate, however, suggest policy is likely to entrench the price gains and to offset any rationing of demand. The price increases, therefore, are likely to be sustained. This inflation dynamic also suggests the interaction of financial markets and central bank activity will be different this cycle.

Central bank liquidity reductions in an environment of modest growth and low inflation can be relatively benign for financial markets. But when inflation is rising and there is at least some risk of an overshoot to the topside, financial markets are likely to be more sensitive to tightening.

With fiscal policy cyclically supportive, central banks need markets less than they did in previous cycles to achieve policy objectives. Developed markets are likely to find the coming tightening cycle more challenging than the last.

Richard Yetsenga is Chief Economist at ANZ

This is an edited version of an ANZ Research report. You can read the original report HERE.

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