Central bank mission creep - Capital Economics
Global Economics

Central bank mission creep

Global Central Bank Watch
Written by Jennifer McKeown

There have been several cases of central bank mission creep in recent months, with policy remits widening to cover areas other than consumer price inflation. The Bank of England is now helping to tackle climate change, the Bank of Japan is still trying to support banks’ profitability, the US Fed has adjusted its employment goal to put some emphasis on equality and the Reserve Bank of New Zealand has been tasked with stabilising house prices. In this Global Central Bank Watch, we explain those changes and assess what the implications might be.

  • Mandates have spread into equality, climate change and house prices in recent months
  • Implications are mixed; Fed lower for longer, but RBNZ may need to hike sooner
  • On average, mission creep points to more variable and probably higher future inflation

There have been several cases of central bank mission creep in recent months, with policy remits widening to cover areas other than consumer price inflation. The Bank of England is now helping to tackle climate change, the Bank of Japan is still trying to support banks’ profitability, the US Fed has adjusted its employment goal to put some emphasis on equality and the Reserve Bank of New Zealand has been tasked with stabilising house prices. In this Global Central Bank Watch, we explain those changes and assess what the implications might be.

Pandemic has accelerated a regime shift

We have been saying for some time that a bold shake-up of central banks’ objectives was on the cards. (See our Global Economics Focuses, “Is it time to give central banks new objectives?”, Jun. 2019 and “The death of inflation targeting?”, Dec. 2017). Out-of-control inflation seems to be a thing of the past, at least in advanced economies, and financial stability has already become a more important part of central banks’ thinking. The pandemic and efforts to deal with its economic legacy appear to have accelerated some of the changes which we foresaw. In recent months, a few minor additions have been made to banks’ remits, involving climate change and banks and also some potentially more significant ones relating to inequality and asset prices.

Asset holdings to become greener

In this month’s Budget, UK Chancellor Rishi Sunak said that the Bank of England should support the government’s environmental aims and updated its mandate accordingly. In response, the Bank stated that it would adjust the Corporate Bond Purchase Scheme “…to account for the climate impact of the issuers of the bonds we hold, with a view to adapting our approach by the time of our next scheduled round of reinvestment operations in 2021 Q4.” So, reinvestments are likely to be skewed towards environmentally responsible corporates and away from energy companies in future.

The direct macroeconomic implications are very small since the policy will not affect the size of asset holdings, only the composition. Nonetheless, the change might be significant for the future. Typically, central banks are charged with maintaining price stability in a way that does not affect market functioning and which does not allow them to make judgements about where credit should be directed. This policy marks a break from that and a step into the realm of government policy.

Bank of Japan still eyeing bank profitability

The Bank of Japan’s policy review released this month included only modest changes. But the decision to widen the tolerance band for 10-year JGB yields from ±0.20% to ±0.25% was interesting since it aimed at objectives wider than simply hitting an inflation target. The BoJ has become increasingly concerned about the effects of its ultra-loose policy on financial institutions’ profits and hopes to ease the damage by raising volatility and trading volumes. The decision is unlikely to change the path of inflation for now. But the BoJ has indicated that it might widen the tolerance band further in future and it seems clear that it is not prepared to pursue its elusive inflation target at any cost. The policy marks a step on from the “tiering” of interest rates applied by the ECB and SNB to support the banks and could be a sign of things to come in economies where interest rates are set to remain ultra-low.

Labour market goals morphing into equality aims

The US Federal Reserve’s August Statement on Longer-Run Goals and Monetary Policy Strategy marked a more momentous change. Not only was there a shift to an average inflation target, but the previous maximum employment mandate was adjusted to “a broad based and inclusive goal”. This means a focus on a wider range of indicators beyond the standard unemployment rate. And the inclusive aspect implies a particular desire to ensure that all members of society benefit from the economic revival. Chart 1 shows that unemployment among people without high school diplomas and those from some racial and ethnic minorities rose considerably further than the average during the pandemic and the gap has remained worryingly wide.

Chart 1: US Unemployment Rates (%)

Source: Refinitiv, Capital Economics

The shift in the Fed’s objective widens its scope even further beyond inflation and economic growth into equality. It seems set to wait until the unemployment rates across a broad range of social and ethnic groups have returned to their pre-pandemic levels before tightening policy. Under these circumstances, we would expect the Fed to stretch its average inflation target to the limit, leaving rates close to near-zero even if inflation does surprise on the upside.

RBNZ tasked with stabilizing house prices

Another sign of a significant shift in central bank policy has come from New Zealand, where the Government has required the Reserve Bank to take its goal of stabilising house prices into account from 1st March. House prices in New Zealand have been rising by nearly 20% y/y in recent months. The Bank firmly pushed back when the idea of adding house prices to its remit was proposed back in November. A common view is that central banks should not have more goals than they have policy tools and requiring the bank to set interest rates to both stabilise house prices and keep CPI inflation near 2% arguably sets it an impossible task.

Typically, macro-prudential tools such as loan-to-value ratios are considered more effect in stemming house price gains. But such policies have had mixed success in New Zealand, not least because the government wants to avoid onerous restrictions on first time buyers. We suspect the additional requirement will, at the margin, make the Bank more inclined towards tighter policy settings during house price booms. As such, it’s possible that the RBNZ may hike rates early next year rather than wait until the second half of 2022 as we have forecast.

While New Zealand is a smaller economy, its central bank has been something of a trend-setter, being the first to introduce an explicit inflation target in 1989. It is possible that this latest move will catch on in other economies with overheating housing markets, such as Canada, Sweden or Australia. It might even pave the way to a broader focus on financial market asset prices as part of central banks’ remits.

Inflation to be more variable and typically higher

In all, recent developments have supported our view that a regime shift towards broadening central banks’ scope is underway. The implications of this will vary depending on each economy’s circumstances, but one common theme is likely to be that inflation strays further for longer from central bank targets than it has in the past. In Japan, where the BoJ has struggled to raise inflation expectations, the key risk is deflation. And in the near term, worries about house prices could mean tighter policy and lower CPI inflation than would otherwise prevail in New Zealand.

But for most economies, the result is more likely to be higher inflation. Our assumption is that inflation will be moderately higher over the next decade than the last, at around 2.5% on average in advanced economies, as central banks tolerate an overshoot in order to achieve broader economic goals. This need not be a bad thing. But there is a risk that watering down inflation targets causes a loss of credibility, particularly at a time when indebted governments may be inclined to lean on central banks to keep interest rates low. Accordingly, we would not rule out the threat of a more damaging increase in inflation in future. 

Monetary Policy Developments

Review of recent policy changes

The global rate-cutting cycle that occurred in the wake of the pandemic has ended and even begun to reverse. Advanced economy central banks, including the Fed, the ECB, the BoJ, the BoE, all left rates unchanged at their March meetings.

But in the face of rising inflation, several EM central banks hiked interest rates, and by more than most expected. In Russia, the strong recovery in activity has stoked broad and seemingly persistent price pressures, causing the CBR to increase its key policy rate unexpectedly, by 25bp to 4.50%, in March’s meeting. And in Brazil, policymakers hiked by an even greater 75bps to 2.75% despite relatively subdued underlying inflation. Meanwhile, policymakers in Turkey hiked interest rates by a market-pleasing 200bps (more on this later).

Chart 2: Changes in Benchmark Rates

Source: Bloomberg, Capital Economics

Rate hikes still a distant prospect in most DMs

While headline inflation rates are likely to jump in the next few months, central banks are likely to look through the rise given the transitory influence of oil prices and some temporary supply shortages. Indeed, we anticipate that three-quarters of the central banks covered in this report will keep policy rates on hold this year (see Table 1), including almost all advanced economies. We do not see the US Fed, the ECB, the Bank of England or the Bank of Japan raising interest rates before 2023 at the earliest. This contrasts with the consensus expectation for rate hikes as early as next year in the UK.

One notable exception is Norway, where the Norges Bank has made clear that it will start hiking rates in the latter half of 2021. Given the momentum in the oil and housing markets, we think that the Bank will tighten sooner and faster than it projects and is currently priced into markets.

Table 1: Summary of CE Forecasts for Policy Rate
Net Changes by the End of 2021

Policy Direction

Economies

Easing

Turkey.

No Change

Australia, Canada, Denmark, Euro-zone, Japan, New Zealand, Sweden, Switzerland, UK, US, China, India, Mexico, Poland, South Africa, South Korea.

Tightening

Norway, Brazil, Russia.

Source: Capital Economics

Brazil and Russia to hike, PBoC favours other tools

In the emerging world, we anticipate that interest rates in Brazil and Russia have further to rise. Following the larger than expected hike in Brazil’s Selic rate and a hawkish statement, we now expect a further 200bp of hikes (to 4.75%) over the next three meetings. But we expect the tightening cycle to finish by the end of Q3 as inflation starts to fall back, which is sooner than the consensus anticipates. Since inflation in Russia looks set to remain above target, we expect 25bp rate hikes in April and June, with additional tightening later this year taking the policy rate to 5.25% by year-end.

In China, formal policy rate hikes no longer seem likely this year. But that matters little to the economic outlook since a shift in monetary conditions has already happened. The PBOC has pulled its many alternative levers to reverse both last year’s falls in market interbank rates and the relaxation of bank lending controls. This reversal has triggered a deceleration in credit growth that will weigh on the economy later in the year.

Turkish policy raises risk of currency crisis

We have commented in detail about the shock decision by Turkey’s President Erdogan to sack central bank governor Naci Agbal in our Emerging Europe Service. The key points are that, so long as the lira steadies, we now expect that latest 200bp interest rate hike to be reversed next month, followed by further aggressive easing in the second half of 2021. This will make Turkey’s inflation problem even worse and risk premia on Turkish assets are likely to rise sharply. There is now a very real chance that Turkey is heading for a messy balance of payments crisis.

DM asset purchases to slow next year

As for unconventional policy, the response of the major advanced economies to recent increases in bond yields has been somewhat mixed. The US Fed signalled that it had no intention of adjusting its asset purchases, reiterating instead that it would keep monetary policy extremely loose for a long time yet. We anticipate that it will continue its current pace of purchases of around $120bn per month this year, before gradually tapering purchases in 2022. (See Chart 3.)

Chart 3: Monthly Asset Purchases ($bn)

Sources: Refinitiv, Capital Economics

The Bank of England also chose to respond with firmer forward guidance rather than a change to its asset purchases. While purchases are set to continue for the rest of this year, we suspect that a brightening economic outlook will mean that there is no need for them to extend into 2022.

In contrast, the ECB announced at its March meeting that it would step up its bond purchases. It is hard to know just how much faster purchases will be and there is only limited evidence of a pick-up in pace so far. However, we are pencilling in net weekly purchases in the order of €20bn over the next three months, compared to the average of €12bn early this year. With purchases likely to continue into next year, bond yields should remain significantly lower than those elsewhere.

Table 2: Central Bank Policy Rates

Country

Policy rate

Latest

Last Change

Next Change

(CE Forecast)

End-2021

End-2022

Major Advanced Economies

US

Fed funds target

0.00-0.25

Down 150bp (Mar. 2020)

None on horizon

0.00-0.25

0.00-0.25

Euro-zone

Deposit rate

-0.50

Down 10bp (Sep. 2019)

None on horizon

-0.50

-0.50

Japan

Interest on excess reserves

-0.10

Down 10bp (Jan. 2016)

None on horizon

-0.10

-0.10

UK

Bank Rate

0.10

Down 65bp (Mar. 2020)

None on horizon

0.10

0.10

Other Advanced Economies

Canada

Overnight target rate

0.25

Down 50bp (Mar. 2020)

None on horizon

0.25

0.25

Australia

Cash rate

0.10

Down 15bp (Nov. 2020)

None on horizon

0.10

0.10

Switzerland

Sight deposit rate

-0.75

Down 50bp (Jan. 2015)

None on horizon

-0.75

-0.75

Sweden

Repo rate

0.00

Up 25bp (Dec. 2019)

None on horizon

0.00

0.00

Denmark

Deposit rate

-0.50

Up 10bp (Mar. 2021)

Down 10bp (H1 2021)

-0.60

-0.60

Norway

Sight deposit rate

0.00

Down 25bp (May 2020)

Up 25bp (Q3 2021)

0.50

1.00

New Zealand

Cash rate

0.25

Down 75bp (Mar. 2020)

Up 25bp (2022)

0.25

0.50

Major Emerging Economies

China

7-day reverse repo rate

2.20

Down 20bp (Mar. 2020)

None on horizon

2.20

2.20

India

Repo rate

4.00

Down 75bp (Mar. 2020)

Up 50bp (H1 2022)

4.00

4.50

Brazil

Selic rate

2.75

Up 75bp (Mar. 21)

Up 75bp (May 21)

4.75

4.75

Russia

1-week repo rate

4.50

Up 25bp (Mar. 2021)

Up 25bp (Apr. 2021)

5.25

5.75

Mexico

Overnight target rate

4.00

Down 25bp (Feb. 2021)

None on horizon

4.00

4.00

South Korea

Base rate

0.50

Down 25bp (May 2020)

None on horizon

0.50

0.50

Turkey

1-week repo rate

19.00

Up 200bp (Mar. 2021)

Down 200bp (Apr. 2021)

10.00

12.50

Poland

Reference rate

0.10

Down 40bp (May. 2020)

None on horizon

0.10

0.10

South Africa

Repo rate

3.50

Down 25bp (Jul. 2020)

None on horizon

3.50

3.50

Sources: Bloomberg, Capital Economics.

Table 3: Quantitative Easing & Other Unconventional Policies

Central bank

Planned Asset Purchases & Lending Facilities

CE Forecast of Future Changes

Federal Reserve Bank

The Fed has pledged to continue large-scale asset purchases of about $120bn per month. It also renewed the Paycheck Protection Program Liquidity Facility until the end of June. Other lending facilities will have come to an end by the end of March.

We anticipate that the Fed will taper its asset purchases gradually in 2022 and will ultimately continue to purchase a modest amount of treasuries each month.

European Central Bank

Average weekly purchases this year have been just over €12bn. At its March meeting, the ECB stated that it would significantly step up its asset purchases as part of the Pandemic Emergency Purchase Programme (PEPP) in response to the rise in yields.

We suspect that policymakers will extend net purchases under the PEPP beyond next March, perhaps until end-2022. (At the current pace, the €1.85trn “envelope” will be exhausted by mid-2022.)

Bank of Japan

The Bank maintained its target for 10-year JGB yields at 0.0% but widened its “tolerance band” from ±0.20% to ±0.25% to improve JGB market functioning. It also removed its average monthly purchase target for ETFs, indicating it would only buy them “as necessary”.

We expect the Bank to slow the expansion of its balance sheet as economic activity continues to recover and government debt issuance slows. The Bank may widen its tolerance band for 10-year yields further once the economy has bounced back from pandemic.

Bank of England

The Bank has kept the stock of QE at £895bn and maintained its commitment to complete the £150bn of extra QE launched in November by around the end of 2021. That’s consistent with the pace of QE being slowed at some point form the current £4.4bn a week.

We think the markets have gone too far in pricing in interest rate hikes from mid-2022. Instead, we doubt the Bank will raise rates or unwind QE until 2026.

Bank of Canada

The Bank of Canada has announced that it will maintain the pace of its government debt purchases at $4bn per week. The Bank has signalled that we should expect a reduction in the pace of purchases this year.

We expect the Bank to taper its asset purchases by $1bn per week at every other meeting starting from April, which would bring them to a close by the end of 2021.

The Reserve Bank of Australia

The Reserve Bank of Australia recently doubled its purchases from the usual $2bn per week to $4bn. While the Bank described that doubling as bringing forward purchases rather than a lasting rise, it noted that it was prepared to do more if necessary.

We have pencilled in a third extension to $300bn at the Bank’s June meeting, with the weekly pace remaining at $5bn and the split between federal and state bonds unchanged at 80%/20%.

Swiss National Bank

The SNB has continued to describe the franc as “highly valued” and states that it is willing to intervene in the FX market as necessary.

The recent fall in the franc has eased the pressure on the SNB. We forecast the currency to fall further this year and think that the Bank will be able to avoid intervening heavily in the FX market

The Reserve Bank of New Zealand

The Reserve Bank of New Zealand has pledged to buy $100bn in government bonds by mid-2022. The current pace of purchases is not enough to meet this target.

We expect the Bank to slow its asset purchases further and to end them altogether by the middle of this year as the economic recovery keeps surprising to the upside.

Riksbank

The Riksbank is on track to have spent about three quarters of the SEK 700bn total by the end of June 2021 and expects to use up the entire envelope by the end of this year, when the programme is set to expire. There are no plans for further purchases in 2022.

We do not expect further asset purchases to be announced.

Sources: Central banks, Capital Economics.

Table 4: Calendar of Policy Decisions

Date

Economy

Policy Instrument

Prior

Survey

CE Forecast

26th March

Colombia

Intervention Rate

1.75

1.75

29th March

Kenya

Central Bank Rate

7.00

7.00

30th March

Chile

Overnight Rate

0.50

0.50

6th April

Australia

Cash rate

0.10

0.10

7th April

Poland

Reference rate

0.10

0.10

7th April

India

Reverse repo rate

4.00

4.00

14th April

New Zealand

Cash rate

0.25

0.25

15th April

South Korea

Base rate

0.50

0.50

15th April

Turkey

1-week repo rate

19.00

17.00

20th April

China

7-day repo rate

2.20

2.20

21st April

Canada

Overnight target rate

0.25

0.25

22nd April

Euro-zone

Deposit rate

-0.50

-0.50

23rd April

Russia

1-week repo rate

4.50

4.75

27th April

Japan

Interest on excess reserves

-0.10

-0.10

27th April

Sweden

Deposit Rate

0.00

0.00

28th April

United States

Fed funds target

0.00-0.25

0.00-0.25

29th April

Egypt

Overnight Deposit Rate

8.25

8.25

30th April

Colombia

Intervention Rate

1.75

4th May

Australia

Cash Rate

0.10

5th May

Thailand

Repo Rate

0.50

0.50

5th May

Poland

Reference Rate

0.10

5th May

Brazil

Selic Rate

2.75

3.50

6th May

Norway

Sight Deposit Rate

0.00

0.00

6th May

Czech Republic

2-week repo rate

0.25

0.25

6th May

United Kingdom

Bank Rate

0.10

0.10

6th May

Turkey

1-week repo rate

19.00

13th May

Chile

Overnight rate

0.50

13th May

Mexico

Overnight rate

4.00

4.00

13th May

Peru

Reference rate

0.25

0.25

20th May

China

7-day repo rate

2.20

20th May

South Africa

Repo rate

3.50

3.50

Sources: Bloomberg, Capital Economics


Jennifer McKeown, Head of Global Economic Service, jennifer.mckeown@capitaleconomics.com
Gabriella Dickens, Global Economist, gabriella.dickens@capitaleconomics.com