A change of tack in monetary policy

In the wake of the pandemic, central banks set to work to address issues such as inflation—now at unprecedented levels—highlighting the importance of the energy crisis and supply problems in shaping price levels. The economic recovery on both sides of the Atlantic has been accompanied by monetary policies of the European Central Bank and the Federal Reserve, either through debt purchase programs or interest rates.

However, although inflation is a generalized problem among developed countries, the factors driving the rise among regions are quite different. According to the latest Economic and Sector Outlook report, prepared by MAPFRE Economics, the issue on the European continent is mainly due to exogenous factors, "such as the energy shock and global supply problems, with endogenous factors being of a much more limited nature."

For their part, and with inflation at 7% in the United States, these price pressures continue to be dominated "by rising energy costs, congested demand for consumer goods to the detriment of services and bottlenecks whose oxygenation capacity remains intermittent and uncertain."

Price level control is an issue that must continue to be addressed by the major central banks, although the policies of the ECB and the Fed do not seem to be going in the same direction. What decisions will each of them make during the year?

Federal Reserve

The body chaired by Jerome Powell, at its last meeting in December, introduced new changes in monetary policy, reducing asset purchases by US$30 billion per month. Interest rates remained unchanged in the range of 0% - 0.25%. However, the Fed announced up to three rate hikes for this year and another three for 2023.

At the macroeconomic level, GDP growth estimates remain stable, with slight changes upwards (4.0% versus 3.8% in September) and downwards in 2023 (2.2% versus 2.5% previously), anticipating a recovery in the unemployment level to 3.5% by 2022-2023.

With these forecasts, and despite the fact that economic momentum was affected throughout the second half of last year, the basis for maintaining an accommodative monetary policy seems to be fading and giving way to a path of normalization. In this sense, the MAPFRE Economic Research Department report points out that, as the volume of asset purchases is reduced and interest rates gradually increase, there will be greater volatility in the short term. "In this time frame, it is expected that, as certain bottlenecks begin to dissipate and the trend in consumption fades, the mismatch between supply and demand will take on a more consistent structure," he adds.

In the long term, the experts anticipate that "the economic situation appears favorable and that the Federal Reserve will be able to continue with its objective of reaching the neutral rate of interest," although the risk remains that a lower tolerance of higher inflation could lead to structural damage to the U.S. economy.

European Central Bank

Unlike its U.S. counterpart, the ECB's last meeting anticipated that interest rates would remain constant, while the pace of the pandemic emergency purchase program (PEPP) will begin to slow. As a buffer, they announced a reinforcement in the conventional asset purchase program (APP), so the agency "will not discontinue net asset purchases," according to MAPFRE Economics estimates.

Likewise, it presented its GDP growth forecasts for this year and next, with a moderate revision with respect to previous estimates: "4.2% by 2022 and 2.9% in 2023 (vs. 4.9% and 2.1% previously).

Given the latest PMI data and the increased fragility of the manufacturing sector, the next monetary decisions are likely to be "more measured and flexible." "While it is in line with the Federal Reserve’s bottom line of formulating less accommodation in the future, the stance adopted by the ECB seeks to extend the tightening dynamic over a longer time horizon," the Panorama Report states.

Looking to the more short-term outlook, the monetary policy stance is expected to remain accommodative, ensuring a full economic recovery. However, with a long-term view, the study concludes that "the need to close the gap in interest rate differentials could lead to a more aggressive change in the monetary policy stance in the euro zone, unanticipated by agents and under fiscal asymmetries that could trigger a possible fiscal dominance event."