Careful! Central banks struggle to balance growth with the need to hike rates

For central banks around the world, it’s all about getting the right balance this year.

In key developed nations, central banks will be trying to carefully calibrate monetary policy (read raise interest rates) as their respective economies recover.

Ditto for  the central banks in emerging  nations, where monetary policies will be targeted towards balancing economic growth while preventing capital flight (in other words, raising interest rates).

In both sets of countries, the potential for rate hikes is growing stronger. That means a large swathe of the global economy could be facing a new cycle of rising interest rates.

Consider what is happening in the developed economies.

The US Federal Reserve, for instance,  has begun tapering (winding down) its massive bond purchases programme. As money gets pulled out of the financial system, interest rates are bound to climb higher.

While higher interest rates are not imminent, they are unlikely to fall further from here on, assuming the US economy continues to recover at a moderate pace.

The UK, meanwhile, is a definite candidate for higher interest rates during the year given its rapidly recovering economy and labour market, as are New Zealand and Australia (the latter ended its easy monetary stance recently, although no rate hikes are imminent).

The trick, of course, will be to ensure the economy continues to grow, despite gradual hikes in interest rates.

Only the European Central Bank (which is trying — not very hard — to fend off the threat of deflation) and the Bank of Japan, which is trying – very hard – to rid Japan of two decades of deflation, continue to be monetary easing mode.

Now, let’s consider developing nations. As a group, these countries will be affected by one key trend this year:  with developed nations poised to lead a global economic recovery this year and the Fed’s taper reducing the easy money available, investors will become more discriminating in their investments.

Earlier this year, it became evident that investors were pulling out money from emerging markets and increasingly betting on developed market growth.

 That has led some countries, such as Turkey, India, South Africa and Brazil, to raise interest rates (to persuade investors to hold on to the local currencies instead of selling them for US dollars). Market rumour has it that Hungary, Russia and Mexico could be next.

More emerging countries,under fear of capital flight, will be forced to raise interest rates if financial market turmoil continues.

In addition, countries such as India and Indonesia have important political elections to contend with, which could either hinder or promote much-needed economic reforms later in the year.

That will put the central banks of most emerging nations struggling with a tough act of balancing economic growth against capital flight. In any case, very few developing countries will be penciling in interest rate cuts in the medium term.

Overall, therefore, the picture seems to suggest that the global economy might be embarking on a new cycle of rising interest rates, even as global growth prospects are, admittedly, on a relatively fragile footing. 

It will be quite the balancing act.

[Image Credit]


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