How fast will the upcoming global tightening cycle be?

The Reserve Bank of New Zealand is widely expected to lift the key OCR by 25 bps to 0.5% at its meeting later this month. 

Not only did they have to reverse the rate hikes; they had to take rates down to much lower levels and even conduct QE once rates reached the zero lower bound. If we fast forward to today, there seem to be some developed-county central banks that are lining up rate hikes up very soon; barely sixteen months after the depths of the pandemic-inspired global economic collapse. Are they jumping the gun again, just like the post GFC period, or will rate hikes not just stick but show that the upcoming tightening cycle will be far faster this time around?

The Reserve Bank of New Zealand is widely expected to lift the key OCR by 25 bps to 0.5% at its meeting later this month. Beyond that the overnight interest swaps (OIS) market looks for the OCR to be over 1% in the early months of 2022. In Norway, Norges Bank has highlighted the prospect of a rate hike next month and, of course, if we look at some of the bigger central banks like the Fed and BoE, expectations for rate hikes continue to drift in. What central banks won’t want to do is to make the same mistake as many did after the GFC and hike rates too quickly.

Norges Bank waited just three months to start hiking rates again while, for the RBNZ it was a year. Both had to subsequently unwind the rate hikes in pretty quick order – and then to take policy rates down to even lower levels than during the GFC. Most notably, the ECB fell into the same trap with its two hikes in 2011, eventually falling foul of the euro zone debt crisis. Is it possible that central banks that hike rates soon will have to unwind them again quickly? Mr. Steve Barrow, Head of Standard Bank G10 Strategy thinks unlikely. For a start, the GFC caused not only a deep recession, but it was followed by a real struggle to recover for most countries. In contrast, the pandemic recession has been more of a quick down then up affair for GDP and there are signs that the lingering legacy effects won’t hold economies back as the financial crisis did more than a decade ago.

Another important point is that the fiscal landscape now is very different to the post financial crisis period. Back then governments were very keen to recoup their fiscal losses quickly with many wary that the post-crisis debt problems of countries such as Greece and Ireland could land on their shores. In retrospect, its widely agreed now that government’s tightened policy too much and too quickly in the wake of the GFC. As a result, the pandemic shock has not seen governments rush to tighten policy.

In fact, the euro zone is seeing significant new fiscal expansion through its Next Generation recovery package while, in the US there is up to USD4.5tr of infrastructure spending potentially in the pipeline and, while much of this is costed, we would not be at all surprised if the eventual fiscal spend was actually quite high given that Congress is good at spending and not so good at clawing back. Of course, fiscal policy in the US and elsewhere won’t be as loose as it was at the height of the pandemic crisis, but it will still be generous relative to what we saw a decade, or so ago. And that suggests to us that central banks are taking fewer chances now in hiking rates than many were back in the year, or two after the GFC.

Inflation is an additional issue as well. There was some price pressure not long after the GFC was over but today’s inflation problems do seem far greater and hence more suited to a pre-emptive hike in rates. And it is not just goods and services prices; house prices are flashing big warning signs; something that was clearly not so prevalent after the GFC which, after all, had at its heart an exploding house price bubble in the US. So, Mr. Steve Barrow said that rate increases that should start coming soon and are more likely to stick than those we saw in the post GFC years.