global perspectives
global inflation overshoot remains a key risk.
Global inflation dynamics overshooting is a key risk to our central scenario of a “no recession, yet tricky” year in 2019 as central banks are likely to move into unified hiking mode across the globe and the liquidity pumped into the system post-financial crisis begins to gradually unwind.
The reason why outlook for global inflation is a curious factor for our “No recession, yet tricky” scenario going forward, is that a faster-than-expected rise in inflation can force different central banks, including the Federal Reserve, to hike much faster than what is priced in the markets. This can lead to a tightening in financial conditions, and the fact that leverage in the global economy is so high, it can even lead to a potential recession.
It is not just the Federal Reserve that will remove some of the monetary stimulus in 2019. The European Central Bank (ECB), the Bank of England (BoE), Bank of Canada (BoC) and Sweden’s Riksbank are likely to follow suit. A big unknown – and therefore risk – for investors is whether this involuntarily coordinated tightening of monetary policy could have an adverse impact on financial markets and growth. We believe the focus on tightening will remain strong in 2019, but we expect there will be an elevated sensitivity to overtightening, especially in the case of the ECB.
On the positive side, the ECB has telegraphed its intentions very clearly and is widely expected to end its Asset Purchase Programme (APP) at the end of 2018, while a rate hike is unlikely to occur before the summer of 2019. In our view, September 2019 is the most likely starting point, with some risk of a delayed start.
However, some factors could force the ECB to revise its plan. Firstly, there are signs the economy could be slowing more than expected, which could mean the excess capacity will not disappear as quickly as the ECB expects. Secondly, an escalation of tensions with Italy could have a negative impact on monetary conditions and growth in the single currency area.
Next year is also going to bring about a change in leadership at the ECB and we expect markets to be watching very closely over the next few months as the next chairperson comes under scrutiny.
The path of the Swiss National Bank (SNB) policy is very much linked to the ECB’s. As such, the SNB is very unlikely to hike ahead of the ECB, for fear of the impact it would have on the Swiss franc (CHF).
However, with a strong Swiss economy and a continued tightening of the labour market, inflationary pressures could force the SNB into an early hike. We believe the SNB will do everything it can to prevent this. One way to achieve that goal would be to allow the franc to appreciate in the short term to reduce imported inflation and offset some of the domestic inflation, affording the SNB some patience.
The Bank of Japan (BoJ) is likely the only major player that will not reduce the amount of policy stimulus in 2019. We believe, given the lack of sustained inflationary pressures, and with inflation remaining well below target, the BoJ cannot afford to reduce its amount of policy accommodation, leaving its QE programme and yield-curve targeting framework unchanged. Moreover, with the VAT increase scheduled for next autumn, it is very likely the BoJ would prefer the economy runs hot so it can better absorb the negative impact of the tax increase.
Nevertheless, we would not exclude the probability the BoJ tweaks its yield curve target because of continued upside pressures on Japanese government bonds as global long-term yields increase. But the impact such a change could have on the yen would likely prevent such a move.
For the BoE, if it was not for Brexit uncertainty, they would likely be tightening monetary policy already. As such, we expect the BoE to hike twice next year, in May and in November, conditional on a Brexit deal.
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