...reaching its crescendo in 2Q, when the heavyweights should re-join in the action.
• Fed: Nurturing the green shoots. In contrast to previous cases where monetary stimulus was reactive to a weakening in the economy, we think the Fed will embark on a further round of asset purchases despite the recent data improvement (see US Economics: Fed Thoughts for 2012: Into the Heart of Darkness, December 27, 2011). The aim is to "nurture the green shoots" - support the (weak) recovery as it unfolds rather than allow it to flag again.
• ECB: Activating the circuit breaker. Liquidity provision, past and forthcoming (there is one more 3-year LTRO on February 29), has so far turned the vicious circle of a run on banks and peripheral sovereigns into a virtuous one. However, we are not convinced that liquidity provision will be enough to act as a circuit breaker; hence, we think that the ECB will have to embark on broad based asset purchases of private and public sector assets - but only after taking the refi rate to a new historical low of 0.50%.
Out of a total of 33 central banks under our coverage, 16 have eased policy in various ways since 4Q11; 7 out of 10 DM central banks and 9 out of 23 EM central banks. Many of these central banks will ease further, on our forecasts, while the central banks of Poland, Korea, Malaysia and Mexico, which have not cut so far, will also join in (and the National Bank of Hungary will likely reverse its 100bp of hikes over the course of the year).
Meanwhile, in the real economy... The data of late have generally been characterised by regional divergence. The US had a relatively good 4Q11 (growth was at the upper end of the 1-3% channel that our US colleagues have identified), while the euro area contracted over the same period. Chinese data still look consistent with a soft landing. More broadly, high-frequency activity indicators such as the various Purchasing Managers Indices are consistent with some pick-up in activity across the globe. That is, the global economy may, on the whole, be continuing on the recovery path after what might prove a mid-cycle slowdown.
Benign base case inflation forecast but upside risks... What does all this mean for the global inflation outlook? Our current inflation forecasts give no cause for concern - we expect inflation to remain benign due to past economic weakness and favourable base effects from the previous commodity price run-up. So what's the issue?
• First, the Fed's "nurture the green shoots" maxim implies that the FOMC will be putting the pedal to the metal for almost any reasonable data outturn over the coming months. Other central banks may respond in the same way and press on regardless - or feel compelled to do so due to action by the Fed and the other major G10 central banks. If the current data upside proves sustainable in the sense of representing a genuine cyclical improvement, central banks may end up easing into an already strengthening economy - generating cyclical inflation pressures further down the line. In EM, these would be added to structural pressures which, rather than having gone away, have merely been masked by the softening economy (see QE - What's Different This Time? February 8, 2012).
• Second, if - contrary to our expectations - global growth shifts up a gear, say because of a sustained and vigorous improvement in the US labour market or favourable developments on the Eurozone crisis front (which would bring us closer to our bull case for global growth of 4.2% for this year), the global central bank may again have administered too large a dose of monetary stimulus.
• Third, our inflation forecasts are based on the assumption that oil prices follow the futures curve. However, if QE does push up the price of oil and other commodities from here, our current forecasts will turn out to be too low.
2013 like 2011? The risks to inflation thus look skewed to the upside. Throw commodity prices into the mix - already meaningfully higher recently and the script becomes familiar - reminiscent of the inflation run-up that materialised between 3Q10 and 3Q11: DM easing, EM overheating, higher commodity prices, and all round rising inflation pressures. Our AXJ economist Chetan Ahya is already flagging upside risks to Asian inflation emanating from the forthcoming DM monetary easing (see Asia Pacific ex-Japan Macro Dashboard, February 13, 2012). Indeed, we think the entire global economy could be headed for yet another run-up in inflation - probably becoming visible late this year but unfolding mostly in 2013.
The Merry-Go-Round is alive and well... That's because conditions remain in place for yet another loop on the Global Inflation Merry-Go-Round - a mechanism we highlighted early last year (see The Inflation Merry-Go-Round, January 26, 2011).
1. Super-expansionary monetary policy in the major developed economies, particularly the US, a) contributes to commodity inflation, and b) is imported by EM central banks through (US dollar) soft and hard pegs.
2. Price pressures rise in EM due to domestic overheating and higher commodity prices. Inflation is then re-exported to DM through more expensive goods exports.
3. More expensive imports from EM and dearer commodities raise inflation in DM. In turn, DM central banks initiate the next round by maintaining - or increasing - monetary accommodation if the economy remains weak (possibly due to the double-whammy imported cost shock).
...as long as EM sticks to its US dollar quasi-pegs. Note that EM currency policy is crucial for the Merry-Go-Round. If, and to the extent that, EM economies allow their currencies to appreciate against the dollar - most likely in order to shield themselves from higher commodity prices in dollar terms - then the Merry-Go-Round is weakened. EM then ceases to import the Fed's superexpansionary stance and thus avoids overheating while also mitigating the commodity price shock. The US - or indeed any economy embarking on expansionary monetary policy - will still suffer:
• a commodity price increase in domestic currency terms, as commodity producers are inclined to maintain the value of their exports in real terms,
• an increase in import prices as their currencies weaken against EM.
Conclusions. If the risks to the inflation outlook we sketch here materialise, it will likely have implications for the monetary policy outlook presented earlier. If inflation rises uncomfortably, some central banks - we think mainly in EM - will be forced back to the drawing board. Less easing and/or earlier tightening would likely be the consequence, as some central banks may attempt to get off the Merry-Go-Round. Stay tuned.
The NBH introduced two new facilities: This morning, the NBH announced the introduction of two new facilities: the first one is a two-year variable rate refinancing facility at the NBH rate; the second one consists of a universal mortgage bond purchase scheme. We look at each of them in turn.
i) The two-year facility. The NBH wants to reduce banks' dependence on short-term funding by introducing a two-year facility. Neither the size of the facility nor the collateral pool has been defined at this stage. We would imagine HUF government bonds being eligible (local banks own about €10 billion of local bonds and bills). In terms of conditions, Simor said that this facility would be available only to those banks which undertake not to decrease their corporate loan stock in that period.
ii) The mortgage bond buying programme. This was tried before (in 2010), and with little success, given the low outstanding stock of mortgage bonds. The NBH essentially hopes that by introducing this facility banks will be more willing to issue that paper. In order for this to be the case, the government needs to pass an amendment (drawn up jointly with the NBH) to grant all credit institutions the right to issue mortgage bonds.
How stringent? It is clearly difficult to estimate the impact of the first facility until we have more details on size. In terms of availability, note that corporate credit is actually expanding by around 2%Y (December data). However, this is only due to HUF depreciation, which boosts the value of FX loans to corporates. HUF loans, which we think are the real target of this facility, were contracting at a pace of 3%Y, and they have been falling gradually since 2008. We would imagine that those banks that borrow HUF for two years at the policy rate need to make a commitment to stop shrinking their HUF corporate loan book.
Implications for the economy and monetary policy: The two-year refinancing facility will be launched in March 2012. The mortgage bond purchase programme will be launched a month after the legislation is passed. The NBH thinks that two-thirds of the drop in corporate lending activity since 2008 is due to the fall in credit supply, which the two-year facility aims to address. Of course, the remaining constraint is credit demand from corporates, which may not pick up as much as the NBH would like.
In terms of monetary policy, we think that this is another step that would improve the transmission mechanism in the economy by boosting lending in local currency and increasing the sensitivity to NBH rates. We continue to expect 100bp of rate cuts by year-end. For more background on our views on Hungarian monetary policy, see also "Hungary: On Pragmatism, EU Shackles, NBH Degrees of Freedom", CEEMEA Macro Monitor, February 10, 2012.
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