A synchronised approach to monetary policy

By Jayson Forrest

Although inflation may be easing globally, central banks still have many challenges ahead of them, as they try to balance economic growth and monetary policy. Grant Feng (Vanguard) shares some of the latest insights from Vanguard in relation to its global economic and market outlook.

Looking at the macro environment, the impact of both fiscal and monetary policy on markets and the global economy needs to be a key consideration when investing, says Grant Feng — Senior Economist, Asia-Pacific at Vanguard.

Speaking at an IMAP Independent Thought Roundtable on ‘Investing after the U.S. election — Diverse views on global strategy’, Grant refers to the latest economic and market insights from Vanguard, which supports the view that global inflation is starting to recede. This decline in inflation is happening much faster in some countries, compared to others like Australia. He attributes this decline to the global synchronisation of central banks, particularly in relation to their dual mandates of managing economic prosperity and inflation.

According to Grant, as part of this wider synchronisation of central banks, there will be a greater need for these institutions to balance inflation and economic risks by focusing on three core areas — economic growth, inflation, and monetary policy.

Vanguard believes U.S. growth will remain firm but it’s moderating, and there are signs of fading supply side tailwinds.

The labour market continues to normalise and consumer spending is softening, but from elevated 2023 levels.

Vanguard expects the United States to record 2 per cent growth in 2024 and 1 per cent in 2025. Against this backdrop, Vanguard believes the U.S. will avoid a recession, as its economy remains resilient.

“Globally, growth is stabilising,” says Grant. “Europe is coming out of stagnation, but we expect growth to remain modest, as restrictive monetary and fiscal policy lingers.

In China, we expect policy stimulus to help offset increasing external and structural headwinds to growth, though medium-term sustainability remains uncertain.”

Inflation has peaked in the U.S., but wage growth and shelter inflation (the effect of shelter costs — like the cost of housing and rental prices — on the overall CPI) remain sticky. Grant says it’s likely the ‘last mile’ (the final stage of reducing inflation to the target rate set by central banks) to target inflation may take more time to achieve.

Vanguard expects core inflation to stay at 2.8 per cent by the end of 2024 and 2.1 per cent by the end of 2025.

“Global inflation has started to decline. We are now seeing central banks focusing more on the full employment side of their dual mandate, which means that for most developed markets, central banks have begun cutting interest rates,” he says.

“In Europe, price pressures are softening slightly faster than expected. In China, inflation is likely to remain subdued and well below the People’s Bank of China’s (PBoC) 3 per cent target, given supply-demand imbalances and a persistent negative output gap (the actual economic output is below the Chinese economy’s full capacity for output).”

With the dual mandate in focus, the Federal Reserve started the easing cycle with a 50bps cut. Vanguard expects the Fed to cut another 50bps in 2024 and reach 2.9 per cent by the end of 2025.

“With the Fed joining the easing cycle, we can expect to see greater synchronisation among central banks globally,” says Grant. “The balance of risks appears to be shifting quickly for the European Central Bank, and we expect rate cuts on a quarterly cadence, with rates reaching neutral by mid 2025.

In China, we expect further rate cuts in 2024 and 2025 to facilitate fiscal expansion and fight the risk of deflation.”

Looking ahead, Vanguard is expecting below trend growth in 2025, with growth expected to decelerate as supply tailwinds fade. It bases this view on four powerful growth forces that are beginning to recede:

1. Consumer excess savings have largely been depleted;

2. The boost to the labour force from immigration is moderating from its peaks;

3. The ratio of job openings to unemployed is approaching a better balance; and

4. The ‘cyclical’ productivity boost is likely behind us.

Grant explains: “In terms of consumption, the excess savings accumulated by consumers during COVID has almost been depleted. We’re also seeing the U.S. labour market, which has been driven by immigration, starting to moderate from its peak,” says Grant. “Importantly, we see U.S. supply side productivity growth also starting to moderate, and the cyclical productivity boost is likely behind us now, and will revert back to trend growth".

“So, while we believe U.S. inflation has largely been tamed, unemployment is starting to drift higher. That’s why the Fed has joined the easing cycle, and we expect greater synchronisation among other central banks globally, perhaps with the exception of Japan.”

Grant says that after almost three decades, Japan appears to be exiting its deflationary cycle and begin normalising its monetary policy. This has certainly put Japan back on the radar of global investors.

“When looking at Japan, we see a virtuous cycle (a series of events that build on each other to create a continuous process of improvement) in sight between wages and prices, which will benefit the Japanese economy,” he says. “Due to these factors, we expect the Bank of Japan (BoJ) will continue to normalise its monetary policy. However, the BoJ will also need to consider its exchange rate and market volatility. If the Japanese yen gains some momentum and capital markets remain stable, the likelihood of the yen depreciating is greatly reduced.”

Considering these factors, Grant expects the BoJ to continue to normalise its monetary policy, but with the caveat that if there are any external shocks, then the BoJ will take a more cautious approach with its monetary policy.

Grant adds that benign growth and inflation in emerging Asian countries, compared to developed markets, is enabling emerging market Asian central banks to also cut rates, but the rate cuts are likely to be slower and shallower than the Fed.

And what about China?

Grant acknowledges there has been a lot of recent discussion about China, particularly in relation to policy stimulus, as China reprioritises its economic growth to fight the risk of deflation.

“China’s policymakers include both the government and the central bank (PBoC). But while most Western central banks only have two mandates, the PBoC has multiple mandates. We believe the PBoC has started to move the importance of economic growth to a higher level.”

According to Grant, the move by China to reprioritise its economic growth to fight the risk of deflation can be clearly seen in recent policy pivots and priority shifts coming out of Beijing.

As an example, he points to the PBoC, which is focusing on four core objectives: stability of currency value; economic growth; full employment; and broadly maintaining its balance of payments. It is also targeting two dynamic objectives: financial reform; and financial market development.

In comparison, Chinese government policy is focused on seven major objectives: economic development; opening up and reform; social stability; common prosperity; technological innovation; national security; and self-reliance.

“Looking forward, we believe fiscal stimulus needs to do the heavy lifting in China. That’s because monetary policy has likely reached its limits due to weak demand and business confidence.”

Grant Feng, Phd is Senior Economist, Asia-Pacific at Vanguard.

He delivered an economic and market outlook at an IMAP Independent Thought Roundtable on ‘Investing after the U.S. election — Diverse views on global strategy’.