Federal Reserve updates
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This has been a big week for central bank meetings but the most significant, without doubt, was that of the Federal Reserve. While the US central bank is not ready to slow its bond purchases quite yet, the announcements after its meeting marked an inflection point — from unrestrained support for growth and financial markets to the long process of winding down stimulus and eventually tightening.
Jay Powell said the Fed could “easily move ahead” with announcing a “taper” of its asset purchases in November if the economy continues to improve as it expects. That was largely foreseen, which explains the shrug from the markets. But two other pieces of information added a hawkish note to the Fed’s guidance. When the taper comes, it will be steep; the Fed chair said purchases could end completely around the middle of next year, from $120bn a month today. And half of the Fed’s rate-setters now expect interest rates to start rising as soon as next year. The central bank is setting a measured but determined course for the exit.
It is doing so, however, just as the economy becomes more uncertain. US jobs numbers were unexpectedly weak last month, and the recovery has in some respects flatlined as the Delta variant has caused a pick-up in the pandemic across much of the country. Indeed the Fed’s policymakers downgraded their 2021 growth expectations just as they raised their inflation expectations, compared to their projections in June. In other words, they identify more adverse supply-side conditions than before, worsening the trade-off a central bank must navigate between growth and inflation risks.
For all that, the Fed is right to prepare the ground for a withdrawal of stimulus. Its own pre-announced criteria for doing so are becoming satisfied. If the economy does progress as the Fed projects, all the signs are that it can start the tightening cycle without causing turmoil in the markets. That would testify to the Powell Fed’s deft management of both economic conditions and market psychology.
The danger is that this path is a hostage to fortune, and in particular that the Fed will find it hard to delay, let alone reverse, the promised “normalisation” if the economy disappoints. Yet the Fed should not regard reversing course as a humiliation. Policy should be guided by data, and the data are uncertain. It may be well into next year before the future path of inflation becomes clearer. For now, as it steers through the current fog, the Fed should be ready to change course rapidly if hazards suddenly loom.
What goes for the Fed is also largely valid for other central banks. They confront the same dilemmas and uncertainties, with greater or lesser intensity. The Bank of England, in particular, faces a strong rise in inflation while UK economic output remains some distance below pre-pandemic levels. Britain’s economy is also more vulnerable to external fluctuations than those of the US or the eurozone.
While the BoE’s monetary policy committee left policy unchanged on Thursday, it may well have to make the unpalatable choice of starting to withdraw stimulus in the coming months. Some other central banks, in contrast, face sufficiently benign conditions that tightening looks safe: in Norway, Norges Bank decided to raise its policy rate a quarter-point above the zero level it hit last year, and signalled a further rise in December.
After 13 years of easy money, policy will remain highly accommodative for some time yet, even if Fed tapering proceeds as planned. The exceptional policies of the Covid crisis, however, are starting to come to an end.