Set for a bumpy ride as central banks change their priorities

Central banks have changed the way they react to economic conditions, largely focussing on current inflation and its impact on expectations at the expense of future growth. Their fear now is that high inflation could influence expectations, and in turn wages, engraining inflation. This shift is the reason for downgrades to our H2 2022 and 2023 advanced economy growth forecasts amid upgrades to our policy rate forecasts.

What you will learn:

• The magnitude of supply shocks to product and labour markets and the uncertainty that they have created over the level of inflation in 18 months’ time – the horizon that monetary policy is effective – has forced the Fed, ECB, and BoE to focus on current inflation.
• Our policy rate forecasts must reflect how we expect policy makers to react – not what they should do based on our growth and inflation forecasts. In that context, our July forecasts are set to move closer to a major growth slowdown as financial conditions tighten. We think the respite from rate rises will come only when inflation has fallen substantially, and cuts are unlikely to begin before inflation is very close to target and growth is well below potential.
• Overall, we think the risk to our policy rate forecasts two to three years out are evenly balanced. On the one hand the risks of entering a higher inflation regime are greater than they have been at any point in the past few decades; but on the other, with the economy in a mature phase of the cycle, a recession and lower rates cannot be far off.