Tuesday, September 7, 2021
The Covid-19 pandemic was an unprecedented shock to a large majority of global economies. But the economic damage was met with an extraordinary global monetary response with the Federal Reserve (Fed), European Central Bank (ECB), the Bank of Japan (BOJ) and the Bank of England (BOE) all providing emergency levels of monetary accommodation. As seen in the LPL Research Chart of the Day, central bank balance sheets have grown by $10 trillion since the start of the pandemic and are currently at $25 trillion for the Fed, BOJ, ECB and the BOE, combined.
While we are hopefully past the peak of the pandemic, monetary accommodation continues largely unabated. However, there will likely be a reduction of monetary support in the coming years as global economies continue to recover. Following is what is currently ongoing from major central banks and what the next steps are likely to be for the Fed, ECB, BOJ and BOE.
Current monetary policy remains very accommodative
- The Fed is currently purchasing $120 billion a month of Treasury and Agency mortgage-backed securities (MBS). Since early 2020, these purchases have grown the balance sheet by more than 80%.
- The ECB is currently buying bonds under its €85 trillion Pandemic Emergency Purchase Program (PEPP) and approximately €20 billion a month through its Asset Purchase Plan (started in 2014). Both QE programs have increased the size of the balance sheet by 80% since the beginning of the pandemic.
- The BOJ increased its Japanese government bond (JGB) purchases to an ¥80 trillion annual pace and increased purchases of commercial paper, corporate bonds, and exchange-traded funds. Together with the bank’s increased lending facilities, the new asset purchases have increased the size of the balance sheet by roughly 25% since the beginning of the pandemic.
- The BOE put in place a £875 billion program to support the UK economy and financial market functioning. The bank’s asset purchases have increased the size of the balance sheet by more than 90% since the beginning of the pandemic.
“Monetary support has helped limit the economic damage from the pandemic but now may be the time to start removing some of those emergency levels of support,” noted LPL Financial Fixed Income Strategist Lawrence Gillum. “However, gently taking your foot off the accelerator is different from applying the brakes. We still expect monetary policy to be supportive for the foreseeable future.”
What is likely to happen next?
- The Fed will likely start to taper its bond purchases either late 2021 or early 2022 with interest rate hikes penciled in for some time in 2023. The details of the taper are not known at this point but we would expect a prorated reduction in Treasury and MBS over a 6-9 month window. We’re likely to get additional details after the next meeting on September 21 and 22.
- For the ECB, PEPP is due to run until at least the end of March 2022. Inflation readings have come in hotter than expected in the Eurozone so the hawks are talking about the need to taper bond purchases sooner rather than later. We will likely get more details following the ECB meeting on September 9.
- Sustained inflation readings at or above target have been, and remain, a challenge for the BOJ. The bank doesn’t expect inflation to reach its 2% target until 2024, at the earliest. As such, easy monetary policy is likely to remain after the other advanced economies start to reverse course. The next BOJ decision occurs on September 22.
- The BOE has recently stated that “some modest tightening of monetary policy is likely to be necessary” over the next two years to keep inflation under control. As such, the BOE is expected to start to increase interest rates next year and is on pace to normalize monetary policy before the Fed and the ECB. More details are likely to come after the conclusion of the September 23 meeting.
As the global economic recovery continues, current levels of emergency monetary accommodation are no longer necessary, in our view, and we are likely to see central banks start to adjust policy. To be clear though, the reduction in these emergency level policies should not be construed as tightening. While we expect the eventual reduction in asset purchases from most central banks to happen soon, interest rate hikes, especially in the U.S., are still several years away, in our opinion. Monetary policy is likely to remain accommodative for the foreseeable future.
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