2018 Recap – Monetary Policy at a Glance

The year 2018 started with a lot of optimism. Investors looked to 2018 with enthusiasm as some of the major economies closed 2017 on a strong note. This came as central bank leaders across the developed economies beat the drum and sang to the tunes of policy tightening.

Read last year’s Monetary policy commentary here.

Indeed, investors were bracing for a year that would see central bank weaning the markets away from easy monetary policy.

However, it was not the same case everywhere despite the larger narrative. In fact, among the major central banks, it was only the U.S. Federal Reserve, followed closely by the Bank of Canada which managed to deliver on their promises.

As a new year starts, here’s a brief recap of the monetary policy decisions that influenced all spheres of life, from funding costs for investors to the average person looking to buy a home.

Federal Reserve Bank of the United States

The Fed led the way, delivering four rate hikes in 2018. Investors started the year speculating that the Fed would not be able to deliver more than three rate hikes this year.

The narrative quickly shifted as the U.S. economy started to pick up steam in the second quarter. A brief surge in inflation caught most investors by surprise.

This resulted in a panic in the equity markets towards the latter part of the second quarter. A surge in inflation led many to believe that the Federal Reserve would hike rates more aggressively.

However, thanks to U.S. President Donald Trump who took every opportunity possible to put pressure on the Fed to lower interest rates, Trump eventually saw the Fed Chair Jerome Powell yielding.

In a quick turnaround, the Fed chair announced in late October/early November that the U.S. interest rates were near neutral. This comes as the Fed delivered its final rate hike of 2018 at the December meeting.

Bank of Canada – Steady as she goes

The Bank of Canada slowly but surely kickstarted its tightening cycle. Delivering three rate hikes in 2018, the BoC followed up after the two initial rate hikes in 2017.

The central bank managed to tighten policy despite navigating uncertainties such as the NAFTA trade agreement with the United States and Mexico.

The central bank was seen closely watching the developments on trade with the United States as it delivered one rate hike after another in 2018. The economy got a boost especially from the rally in the crude oil prices.

Meanwhile, the economy managed to take advantage of the conditions growing a healthy pace and sustaining the momentum. Add to this the improvements in the labor market; inflation spiked above the BoC’s 2.0% inflation target rate.

Bank of England – A balancing act

What can a central bank do when inflation persistently overshoots its target while the economy stares into an abyss of uncertainty?

Meet the Bank of England. The BoE started off the year in hopes to hike rates three times. However, a surprise slowdown in the economy in the first quarter and increasing uncertainty due to Brexit saw the BoE hiking rates just once in 2018.

The Bank of England has however warned that interest rates could rise if inflation continues to trend higher, a scenario that could very well be possible if the UK manages to crash out of the EU with no deal in hand.

Wage growth was a concern. At one point, inflation outperformed wages, putting real wages under pressure. However, following the one rate hike in 2018, inflation was seen somewhat stabilizing. This gave some breathing room for the labor market to catch up as wages started to rise.

But questions remain on what the future would look like for the BoE. The Brexit deadline is March 2019, and so far, no deal has been in place. Making matters worse, the UK parliament and the PM May’s own party, the Conservatives, are starting to lose patience in the leadership.

The BoE will remain on the sidelines, and the Brexit deal is likely to be a cliffhanger.

The European Central Bank – Taking a cautious route

The Eurozone economy started the year 2018 on a big bang following a strong close to 2017. However, growth started to falter quickly right from the first quarter. Optimists brushed aside the blip as being temporary and maintained that growth would still pick up.

But the auto emissions standards hit the German economy hard which continued to drag the rest of the Eurozone’s economic growth lower.

Despite the slowdown, inflation was the big surprise. Consumer prices eventually started to trend higher as the headline CPI managed to remain steady at the 2.0% handle, the very inflation target that the ECB was targeting.

However, core inflation had a different story to tell. Still, compared to the years before QE, inflation in the Eurozone is much higher than it was.

Therefore, its no wonder that the ECB saw most of 2018 tapering its QE program and eventually ending it in December. Investors wasted no time speculating on the interest rates as QE was coming to an end, and ECB President Mario Draghi was quick to squash the speculation.

The ECB does not expect to hike interest rates anytime soon and looks to be in no rush. With economic data still somewhat on shaky grounds, the ECB is only expected to make a rate hike decision during the second half of 2019.

The decision is, of course, is subject to the assessment of the incoming data.

RBA and the RBNZ – Will the patience pay off?

The Reserve Bank of Australia and the Reserve Bank of New Zealand were literally muted for the whole of 2018. Interest rates remained unchanged as the central bank sought to buy more time. Both the central banks remain hopeful that growth will start to push inflation higher.

There are some signs of this already, especially from Australia where unemployment reports over the past few months have been encouraging. Still, the labor market has a lot more slack to absorb. This means that wage growth will stay muted for the foreseeable future.

Both central banks have also maintained a neutral tone in terms of forward guidance – perhaps this underlines the cautiousness from the central banks. Meanwhile, investors have been flip-flopping on the timing of the rate hikes from the RBA and the RBNZ.

Bank of Japan and the SNB – Wait and watch

The Bank of Japan did not make any big strides with its monetary policy in 2018. At best, the central bank tweaked its QQE program by switching to controlling the yield curve. The BoJ started purchasing shorter-dated bonds in order to keep the yield at or near the zero level.

The central bank has also been very patient as inflation in Japan remains stubbornly low. It is the same story with the Swiss national bank as well. Interest rates in both the economies are in negative territory, a stark contrast when compared to the BoC, the Fed or even the Bank of England.

The big challenge for the BoJ will be the October 2019 sales tax hike. Question is whether this will have the intended effects on inflation. As for the SNB, unless the ECB moves its rates higher, the Swiss national bank is very likely to sit on its hands.

What’s ahead in 2019?

Talks of a late economic cycle have raised concerns about recessions. It is no wonder then that central banks are scurrying to lift rates and end QE programs in order to position themselves when the next crisis hits.

A few weeks ago, talks about an inverted yield curve in the U.S. sparked debates on whether a recession is just around the corner.

Whatever it may be, for the year ahead, central bankers are likely to take a more cautious tone when it comes to policy tightening. A surprise boom in the economy could no doubt support a majority of central banker’s view to continue with policy tightening.

On the flipside, signs of a slowdown could see interest rate hikes being stalled. Will there be rate cuts? We’ll leave that topic for the middle of 2019.