In his latest quarterly Economic Outlook, Neil Williams, Group Chief Economist at Hermes Investment Management, points out that ten years after the first glimpse of the financial crisis, and major economies have finally recouped their GDP (Chart 1, below). Even Japan, whose deflationary crisis originated two decades earlier and Italy, hamstrung by the euro, are back to ‘square one’.
Arguably, most of the macro effects from the crisis were not registered till 2008, which then triggered a round of monetary stimulus - conventional and unorthodox - unparalleled since the 1930s.
Chart 1. Major economies have recouped their nominal GDP
Nominal GDP re-based to Q1 2017 (=100). Grey denotes US recession
Source: Thomson Reuters Datastream, based on national data
Output recoveries since 2009 have yet to generate the inflation central banks crave…
So, with recoveries now maturing, unemployment rates lower, and asset prices bloated by eight years of cheap money, central bankers (for example, at June’s ECB Forum in Sintra) are increasingly striking a more hawkish tone.
But, despite this ‘muscle flexing’, the road to policy normalisation is likely to be long and slow, with the prospect of another two years of negative real policy rates in the US, UK, Japan, and euro-zone.
The US Fed could, by running QT, take out as many as five extra rate hikes by 2019…
Our analysis suggests that by sustaining its proposed QT programme, the US Fed could ‘take out’ as much as 130bp of further rate hikes by 2019. US policy rates, when they peak, should be far lower than we’re used to.
But, the frustration for all G7 central banks is that recoveries since 2009 have mainly been output driven. And, with output gaps slow to close and wage pressure still capped, they’ve yet to generate enough inflation to trigger central banks’ usual reaction functions (Chart 2).
Chart 2. But, these are output recoveries that have not generated inflation
Real GDP growth & CPI inflation rates since 2017. Averages, both %yoy
Source: Hermes Investment Management, based on national data
BoE seems loathe to tighten before Brexit, keeping monetary conditions ultra-loose…
The one main economy that has delivered inflation is the UK, which is doubtless a symptom of the pound’s decline. Yet, the BoE looks loathe to raise rates during the Brexit process. While the CPI should stay above target, the inflationary flame may snuff itself out.
The ECB, meanwhile, could taper its QE by ‘natural causes’ as some members’ buying limits approach. It could fill the gap by buying proportionately more from others, but this may not be palatable to Germany as it questions Mr Macron’s unified budget proposal.
In Japan, Mr Abe still has every incentive to prolong a policy loosening now in its nineteenth year. It may be the last to end QE. While in China, even if President Xi after his autumn reshuffle addresses asset-price bubbles, rising corporate debt, and shadow banking, its policy tightening should be limited.
The more serious risk is the ‘P’ word - protectionism…
The more serious risk is US trade tariffs, where Mr Trump could still invoke ‘Super 301’ to bypass Congress. In which case, without care, an unhelpful jigsaw piece from the 1930s - retaliatory trade protectionism - might yet come crashing into place. And, linked to that, it remains to be seen how more combative US/China relations become over North Korea.
So, all in, this gives credence to the ‘new normal’ view of low-for-longer rates, rather than an imminent return to pre-crisis levels. In which case, the most we might expect - even in 2019 - is not for policy to become tight again by traditional standards, just less loose.