Shamik Dhar, chief economist at BNY Mellon Investment Management, on the outlook for central banks

by | Aug 8, 2023

Shamik Dhar, chief economist at BNY Mellon Investment Management comments on the outlook for central banks:

“The story for the past 12-18 months has been quite consistent across the major central banks. The Fed, ECB and BoE have been in catch up mode, facing a substantial economic inflationary shock and reacting to that by raising interest rates dramatically. These central banks’ common story persists to a degree, in that it is generally accepted that they are now approaching the peak in interest rates. Indeed the Fed, ECB and BoE each raised interest rates by 25bps at their most recent meetings. 

“Although this superficial similarity is still there, there are different decisions to be made going forward. This divergence could have implications in driving asset prices and investment increasingly going forward when compared to the past 12-18 months. 

Fed – Recession more likely than immaculate disinflation

“Although we suspect the risks are to the upside, broadly speaking the expectation is that the Fed is nearly done because there are emerging signs of weakness in the US economy. But also if there is going to be a soft landing and immaculate disinflation – meaning, the slowdown doesn’t necessarily turn into a recession – the US seems to be the prime candidate for this outcome, out of those major economies. Partly because its labour market appears to be more flexible than others. However, we still view a recession as more likely than not, but the debate in the US and at the Fed is slightly different, and more informed by a slightly higher probability of a soft landing than in other jurisdictions.

ECB –  Hawks at risk of doing too much 

“The Eurozone is, technically speaking, in a recession given it has had two quarters of falling output and a fall in Q3 looks likely. Despite that, because inflation remains stickily high the ECB’s reaction function is slightly different than the Fed. There is more of a hawkish bias at the ECB.  To us, if there is a region at risk of doing “too much”, it’s likely the Eurozone. 

“We may well see inflation come down sharply next year. But if we’re going to see a period of prolonged recession, and inflation coming down – possibly to undershoot targets sooner than most people think – then the Eurozone is primed. 

Bank of England – Ongoing stagflation story

“The UK is a bit more stagflationary than most of the other regions, with perhaps the exception of the Eurozone. Inflation is persistent and sticky and therefore, while the markets have revised down their expectation of the terminal rate, the risks are evenly balanced in the UK. It is not clear that the inflationary psychology has been punctured quite to the extent in the UK that it has in other jurisdictions. Therefore, there will be debate on the MPC about what the optimal path of monetary policy is from here. We think risks lie to the upside. 

“Though the Fed, ECB and BoE all raised rates by 25bps in the past weeks, their similar story is likely nearing an end. Increasingly for equities, fixed income markets, and currencies, these nuances that are emerging between central banks are going to become increasingly important for investors to watch closely.”

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