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Saturday, April 24, 2021
Global Monetary Policies in Divergence
ANBOUND

In 2020, the global economy suffered greatly as a result of the COVID-19 pandemic. Because of this, central banks of various countries, led by the Federal Reserve, have adopted loose monetary policies to alleviate the impact of the pandemic on the economy and to assist in its recovery. This however, has further exacerbated the already existing global liquidity issue. Since the beginning of this year, as the effects of the pandemic have gradually begun to subside, the global economy began to recover rapidly as a result. It was also at this time that concerns about inflation caused by continued monetary easing started to appear. ANBOUND's researchers have noticed that the simultaneous pressures of both economic recovery and rising inflation are causing monetary policies of various countries' central banks to diverge.

Regarding how the situation in the first quarter has progressed, the difference in policies between developed markets and emerging markets has been quite obvious. The Federal Reserve and the European Central Bank (ECB) have made it clear that they will continue to stick to the easing policy while it is expected for Japan to keep its interest rate policy unchanged. Canada on the other hand, still insists on its interest rate policy, though the scale of easing has been reduced, and it is the first among the G7 countries to do so. Both the Fed and the ECB mentioned that they will not be raising interest rates before 2023. Instead, they will take corresponding measures to reduce the size of QE to achieve the transition. Conversely, some economies in emerging market countries have begun to raise interest rates and promote changes in monetary policy. In the first quarter of this year, Brazil, Turkey, and Russia were among some of the countries that raised interest rates, being the first economies to enter an interest rate hike cycle since the pandemic. In fact, both Turkey and Russia have experienced at least two rounds of interest rate hikes to cope with their high inflation levels. The recent inflation level in Turkey has exceeded 15% while the inflation levels in Brazil and Russia have exceeded 5%. Emerging markets such as India, Malaysia, and Thailand all show that market expectations for monetary policy tightening are increasing.

Inflation is the basis for determining monetary policy adjustment. The World Bank recently stated that, driven by strong economic growth in the first quarter, global commodity prices are expected to remain near current levels this year. It also predicts that average energy prices will increase by more than one-third this year, and metal prices are expected to rise by 30%. Among them, the price of copper is expected to rise by an average of 38% this year, boosted by strong demand for construction and consumer goods. Fed Chairman Jerome Powell recently stated that economic strengthening and tight supply will push up the price levels of certain industries which will cause the U.S. economy to temporarily experience a temporary increase in inflation this year, but the Fed will work to control excessive inflation within a certain range. It is safe to say that rising global inflation, either mild or severe, will be a major trend for some time to come. This is an effect brought about by the loose monetary policy that was implemented globally and it is also a prerequisite for the divergence and shift of the monetary policies of various countries. In fact, the current market divergence on inflation and monetary policy trends is very clear and there have been fierce debates on this matter. This means that with the gradual increase in inflation, global central banks have already reached the crossroads in monetary policy adjustment, even if the pace of adjustment differs in various countries due to their differing conditions.

The different policies of central banks in various countries as well as the levels of inflation depend on the COVID-19 situation and the economic recovery of each individual country. On the one hand, the impact of the pandemic on the global economy last year was uneven. According to the IMF, due to differences in economic structure and medical security capabilities, the impact of the pandemic on underdeveloped economies last year was even more severe. On the other hand, in developed countries or regions such as certain European countries and the United States, the outbreak of COVID-19 is gradually being brought under control due to the rapid roll out of vaccination. On the other hand, the current pandemic situation in emerging market countries such as India and Brazil is worsening. This will lead to a widening gap between the economic growth of these countries and the developed countries.

The economic recovery in the post-pandemic period also varies from country to country. As indicated by the IMF, regions and countries with different income levels have different rates of recovery. This is also reflected in the significant differences such as the speed of vaccine roll out, economic policy support, and structural factors such as the degree of dependence on the tourism industry. In advanced economies, the GDP of the United States is expected to exceed its pre-pandemic level this year, while it is expected that many other countries will not return to their respective pre-pandemic levels until 2022. Similarly, among the emerging markets and developing economies, China's GDP has returned to pre-pandemic levels in 2020 while it is expected for many other countries to only be able to achieve this in late 2023.

It is precisely because of the difference in both the pandemic response and the economic recovery that have led to the divergence of monetary policy. However, the economies of all countries were able to benefit from the loose stimulus policies implemented last year. This year, emerging market countries have adopted austerity policies such as raising interest rates. This is not only due to domestic factors, but is also heavily impacted by the spillover of the Fed's policies. These countries are being affected by the strong U.S. currency. The strengthening of the U.S. dollar and the rise in market interest rates such as the yields of U.S. long-term Treasury Bonds are making international capital returning to the United States from emerging markets, bringing capital outflows from emerging market countries and further affecting the economic recovery of these countries.

The raise of interest rates in emerging market countries will naturally increase investment and capital costs which is not conducive to the long-term economic growth of these countries. However, due to economic structure defects and economic scale limitations, the impact of such costs is still lower than currency devaluation and hyperinflation. Li Chao, chief economist of Zheshang Securities, believes that early interest rate hikes in emerging markets are necessary in order to prevent cross-border capital outflows. The prevention of a negative spiral of inflation and currency devaluation would also be one of the reasons why emerging market countries are gradually starting a wave of interest rate hikes. From this perspective, the adjustment of monetary policies made by emerging market countries can be considered as a passive move, with the intention of slowing the impact of the rise in the U.S. dollar.

ANBOUND's researchers are of the opinion that the situation in China is different from that of other developed markets that are in the early stages of recovery, and from other emerging markets that are experiencing deterioration. On the one hand, China has shown better results in controlling the COVID-19 situation, and its economy was the first to recover; on the other hand, China's domestic supply and demand are more balanced, with emphasis given on its economic "inner circulation". With the gradual recovery of the economy, China's monetary policy from the second half of last year has gradually returned to normalization. All of this results in China's economy receiving a relatively limited impact from the changes of the dollar liquidity and international capital flows. This actually constitutes a unique third type of normal market. China's macro policies which include its monetary policy, needs to maintain the stability and vitality of this market, and avoid the impact of external inflation and capital flows.

Final analysis conclusion:

As the global monetary policy is continuing to diverge while the global economy and market environment remain highly uncertain, China's current monetary policy still needs to be maintained within the normal range. It should strive to maintain a normal market environment as well as currency flexibility in addition to stabilizing foreign trade and investment. Through such approaches, China will be able to gain market space through its internal growth.

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