Alicia García Herrero (Natixis) | This has not been an easy year despite the strong fiscal and monetary support to Covid-struck economies, especially in the Western world. Such support has allowed the North American and European economies to grow above potential amid repeated waves of Covid-19 and related mobility restrictions even if less severe than in 2020. On the other hand, the emerging world has grown below potential this year because of limited stimulus policies and even more rigid restrictions on mobility than in the West given the still-low rates of vaccination against the virus that causes Covid-19.
China is an intermediate case in the sense that its economy managed to grow strongly in early 2021 thanks to exports and high domestic mobility, which allowed its factories to open earlier than those of other economies. China’s high growth in the first half of 2021 offered the room needed to withdraw fiscal and monetary stimuli, and further control excessive corporate leverage while maintaining a tight control of its borders through its Covid Zero policy. In this context, the final stretch of 2021 offers us a very different panorama. China has gone through a very rapid economic slowdown in the second half of the year, actually a much faster one than in the US or Europe. The weakness of Chinese domestic demand is the main reason the rapid increase in producer prices has not yet been transferred to the Consumer Price Index in China as it has in the US. In this sense, the challenges of the US Federal Reserve, or even the European Central Bank (ECB), are very different from those of the People’s Bank of China (PBOC), for which inflation is less of a problem than the lack of domestic demand. In the case of the Bank of Japan (BoJ), deflationary pressures are so intense that even with the ongoing problems with supply-chain bottlenecks, consumer prices in Japan only grew by 1%. Such economic divergence in the starting position of the main Western central banks versus those in the East is the reason behind what is bound to become the great decoupling of monetary policies in the course of 2022.
In fact, the Fed has begun to reduce its balance sheet, and at a pace faster than the market initially expected. As if that were not enough, at its last meeting a week ago, a consensus was beginning to form to carry out at least two interest-rate increases in 2022. The ECB, though more cautious in the breadth and speed of its withdrawal of liquidity, also became more aggressive at its last meeting than many would have expected, driven by increasingly high and widespread inflation in the euro area. At the other end of the spectrum, the PBOC began cutting its bank reserve ratio three weeks ago, after a hiatus of about five months since the first cut. Furthermore, a few days ago the PBOC cut its reference lending rate by 5 basis points, and additional cuts in the reserve ratio are expected, together with a fiscal boost on the infrastructure space. Finally, at its last meeting, the BoJ made it very clear that it has no intention of following in the footsteps of the Federal Reserve and will, therefore, maintain the size of its balance sheet and, more generally, its ultra-expansionary monetary policy until inflation reaches the central bank’s objective, namely 2%.
With all that said, it seems that 2022 will be characterized by a great divergence of monetary policies between the key Western central banks and those in the East. Such monetary decoupling has important consequences – namely the increase in the cost of financing due to the withdrawal of monetary stimuli in the West could further slow economic growth. This is particularly problematic given recent developments with the Omicron variant of Covid-19 in terms of reduced cross-border, but also domestic, mobility. On the other hand, a higher cost of financing in the West, and especially in the US, should entice the appetite of international investors increasing portfolio flows into the US and supporting a strong dollar compared with the yuan and yen. More generally, more exchange-rate volatility seems guaranteed for 2022 on the basis of such monetary-policy divergence.
All in all, it does not look like 2022 is going to be calmer than 2021, and not just because of the effects of the pandemic, but also because of the great decoupling of monetary policies between the West and the East.
*This article was originally published by Asia Times.
