Global monetary policy: Bolder; Faster

A new strain of the coronavirus bursting in to disrupt end-of-year programs was not the only surprise the end of the year had, for financial markets at least. Central Banks in major economies; the US Federal Reserve, European Central Bank (ECB), and Bank of England (BoE), had a gift for the market – the earlier-than-expected return of a hawkish stance with interest rate. While the Federal Reserve only announced its intention to jerk interest rate in 2022 -up to three times over the course of the year-and the ECB declared the end of its bond buyback program, the Bank of England hiked its central monetary policy rate to 0.25% from 0.1% in its last meeting for the year- a move that caught many off-guard.


Often, it seems the actions of monetary authorities are largely predictable. Employing their trusted tool –interest rate – central banks usually steer the economy lightly, lowering the interest rate to stimulate growth or hiking the rate to control money supply in the economy and rein inflation. This time, however, the emergence of the Omicron variant amid record inflation levels created a conundrum. While it
was largely anticipated that central banks would retain interest rates at pandemic lows in order to cushion any demand-sagging effect the spread of the new strain of the virus might have on the economy, the Bank of England opted to raise the interest rate for the first time in three years to address the alarming climb of price levels in the economy.


While the rise in inflation had initially been tagged as transitory and a fleeting effect of frantic lockdown and post-lockdown efforts to sustain the economy, the outlook on the record-high inflation levels – 5.1% in the UK (a decade high) and 6.8% in the US (a three-decade high) – changed as the rise in prices and wage rate persisted during the course of the year, resulting in an upward review of 2022inflation forecasts – making it clear that the rise in inflation was anything but transitory. The unprecedented climb in price levels has been attributed to supply-side factors such as the rise in global commodity prices coupled with supply chain constraints.

A major concern surrounding the upward shift in interest rate is the timing. Was the decision prompt or ill-timed? In favour of the former, the argument is that since record low rates had contributed to the record-high inflation, an interest rate adjustment would support inflation dampening. This stance is also supported by dipping unemployment levels – a sign of economic recovery and brighter growth prospects. Central Banks around the world including Turkey, Mexico, Norway, Russia, and Hungary have towed the hawkish path taken by the BoE. In countries where the central banks had embarked on a bond buyback scheme, the monetary authorities ended or fast-tracked their bond buyback timeline in line with the hawkish stance on interest rates.


Amidst all this, the picture is different in Australia, where the Bank of Australia insists on maintaining its timeline on its bond-buyback program and delaying interest rate hikes till 2023, amid low inflationary pressures and better labour market prospects. With Omicron cases soaring especially in the United Kingdom as lockdowns and travel restrictions make a comeback, it may seem as though the BoE’s move was too soon. Going forward, monetary authorities are expected to keep an eye out for the economic implications of the Omicron strain. Should the impact be mild, further rises in interest rates would be needed to keep inflation under control. However, should more restrictions be needed, which would negatively impact economic performance, further rate hikes may be postponed.