At the Jackson Hole central bank annual meeting, increasing signs of sluggish growth and risks emerging in the job market have become the reasons for the Federal Reserve to send signals of policy shifts and changes in the trajectory of monetary policy. The actions of the Federal Reserve may encourage more central banks to join, while the Bank of Japan will continue to be one of the few outliers globally. However, the uncertainty of economic recovery and the volatility brought about by previous carry trade transactions make further tightening or becoming more cautious.
The Federal Reserve may initiate a new round of interest rate cuts.
Last week, Federal Reserve Chairman Powell delivered a much-anticipated speech on the outlook for the U.S. economy and sent the clearest message to date that the time for policy adjustments has arrived. Research papers released at the meeting showed that the U.S. economy may be approaching a tipping point, with the continuous decline in job vacancies translating into faster growth in unemployment rates.
The International Monetary Fund (IMF) previously predicted that the global economic growth forecast for 2024 would be 3.2%, and 3.3% for 2025, gradually stabilizing, but with weak growth momentum. Against the backdrop of escalating geopolitical conflicts, frequent international trade frictions, and the rise of trade protectionism, the global economic outlook still has certain uncertainties. As the U.S. achieves a soft landing, Europe's economic growth picks up, and China emerges from the doldrums, the global economy will achieve moderate growth in the coming years.
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Although major central banks are turning to interest rate cuts, it is still too early to determine whether the policy is classified as the "normalization" of restrictive policies or the first step to prevent further economic growth slowdown. IMF Chief Economist Pierre Olivier Gourinchas said, "As major central banks enter a monetary easing cycle after tightening policies to deal with inflation outbreaks, we may see other market volatility events because we are now in an unknown territory."
A potential interest rate cut by the U.S. in September may reduce the pressure on other major central banks to ease monetary policy. Different policy stances and expectations for the next steps of central banks have always been a key driver in the foreign exchange market. Investors seek higher interest rate currencies in so-called carry trade transactions to enhance their value relative to currencies with lower interest rates. Jumana Saleheen, head of the European investment strategy group at Vanguard Group, said, "The policy decisions of other central banks will mainly depend on the economic and financial conditions of each country. But in a globally interconnected world, other central banks cannot ignore the impact of the Federal Reserve on global financial conditions."
European Central Bank policymakers are in agreement on further rate cuts next month, partly due to easing price pressures, but also because the growth outlook has significantly weakened. The Eurozone economy hardly grew last quarter, as the largest economy, Germany, contracted, manufacturing remained in a deep recession, and exports also declined. European Central Bank Governing Council member Olli Rehn said in a recent speech, "The increased risk of negative growth in the Eurozone recently strengthens the necessity for a rate cut at the next ECB monetary policy meeting in September."
Among other developed countries, the Swiss and Canadian central banks have already cut interest rates twice this year and may continue to lower rates. The Bank of England cut interest rates for the first time in four years, and Daniel McCormack, head of research at Macquarie Asset Management, expects the Bank of England to start a potentially moderate but sustained easing cycle. Australia and Norway may start to lower interest rates by the end of the year.
Emerging economies are also eager to act, with the Philippine central bank announcing a policy rate cut this month to boost the economy, the first rate cut since November 2020. "With the consistency of the inflation target, the current macroeconomic outlook supports an adjustment towards a less restrictive monetary policy stance," the statement said, although inflation has risen unexpectedly, domestic growth is sluggish, and the firm expectation of an upcoming rate cut by the Federal Reserve has also strengthened the prospect of its own easing cycle.
The Bank of Korea kept interest rates unchanged last week, but the voting results showed that several members expressed openness to a rate cut in the next three months, sparking market speculation about future policy directions. After revising down economic forecasts, Bank of Korea Governor Lee Chang-yong believes that the existing economic environment is more complex, and the risks to financial stability are increasing.How will the Bank of Japan's future policy unfold?
Amidst a global trend towards a lowering interest rate cycle, Japan has emerged as one of the few economies to act counter-cyclically. However, following the Bank of Japan's interest rate hike in July, there was a significant shock to global risk assets. Considering the potential interconnections, the impact of large-scale unwinding of carry trades has made the Bank of Japan more cautious about its next steps.
Data released last week showed that due to the cancellation of public utility subsidies and a subsequent increase in electricity prices, Japan's core Consumer Price Index (CPI) rose by 2.7% year-on-year in July, marking the third consecutive acceleration and reaching a new high since February. With the rise in inflation, the Bank of Japan is facing increased pressure to tighten further. Bank of Japan Governor Haruhiko Kuroda stated in a speech to parliament on the 23rd that the monetary policy plan will continue to move towards normalization. If the economy and prices align with expectations, the Bank of Japan will raise interest rates. He added that the Bank of Japan is closely monitoring the impact of financial market turmoil on inflation.
However, institutions believe that despite a rebound in consumption in the second quarter, there is still uncertainty about whether wages will rise enough to offset the increase in the cost of living for households. On the other hand, raising interest rates will strengthen the yen, affecting exports and, in turn, impacting economic momentum. "Domestic demand is very weak," said former Bank of Japan board member and current Keio University scholar Sayuri Shirai, "From an economic perspective, there is little reason for the Bank of Japan to raise interest rates in the short term."
Interest rate futures pricing indicates that investors currently expect the Bank of Japan to keep interest rates unchanged at its September meeting and may raise rates in December. ANZ Bank's Head of FX Research, Mahjabeen Zaman, predicts that, judging from Haruhiko Kuroda's recent statements, the Bank of Japan may take preemptive action in October. "Kuroda is more hawkish than the market expected, and his tone is similar to what it was at the Bank of Japan's meeting in July. Fluctuations in the stock market and the yen have not really changed his views; the Bank of Japan's interest rate hike process is not yet complete," she said.
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