Policy normalisation

08 December 2017 | Markets and Economy


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Leo Schulz
Vanguard Europe – Moderator

Peter Westaway
Vanguard Europe – Chief Economist and Head of Investment Strategy

Alexis Gray
Vanguard Europe – Senior Economist

Leo Schulz: Policy normalisation. Since the financial crisis, for nearly ten years now, we have had extraordinary monetary policy and, in many countries, fiscal austerity.

My name is Leo Schulz. I have with me Peter Westaway, chief economist and head of investment strategy at Vanguard Europe, and senior economist Alexis Gray.

Peter, if we look at the chart on the screen, we see on the right hand side the dotted lines that represents expectations of the direction of central bank interest rates, and what we can see is that they're rising. Have we reached a turning point with monetary policy?

Peter Westaway: I'd say yes and no. So let’s start with the United States, the world’s largest economy. Certainly there, policy is tightening. In 2017, they raised interest rates. We’re expecting them to do more interest rate increases in 2018, but also they're reversing their quantitative easing – quantitative tightening they're now going to be doing, allowing the stock of bonds that they previously bought to run down – and all of those policies are going to tighten monetary conditions in the United States. But that should be okay, because the underlying strength of the economy should allow growth to continue.

Then if we turn to the United Kingdom, we also had an interest rate increase there at the end of 2017. That really reversed the interest rate cut that had happened immediately after the EU referendum result. But looking forward, because of the immense uncertainty that there is around the UK leaving the EU, I think we’re really expecting very slow and gradual interest rate increases in the UK over the next couple of years.

Leo Schulz: Alexis, Peter has painted a picture for us of monetary policy in the US and UK, but worldwide, it’s not synchronised, is it?

Alexis Gray: No, monetary policy isn't synchronised. In the euro area and Japan, which are fairly big regions, we still have monetary stimulus. In the euro area, the ECB has really struggled to get back to their 2% inflation target. So we have quantitative easing and interest rates won't rise until at least the middle of 2019. In Japan, we've had incredibly low inflation for a very long time and so once again we have quantitative easing; rates probably won't go up until next decade.

Leo Schulz: Peter, we’re seeing some changes in monetary policy, but we’re also seeing some changes in fiscal policy aren't we? What are your thoughts around that?

Peter Westaway: Well, I don’t think it’s true to say that there has been a wholesale abandonment of the desire to bring down public sector debt, but I think it is true that the tide is turning a little bit on fiscal policy. So, for example, in the United States, the intention is to push through tax reforms and the outcome of that is likely to be mildly stimulative for the US economy. Here in the UK, certainly since the Brexit vote, the UK Government has slightly eased back on the fiscal austerity that was previously in train. And then in the euro area, they went through a number of years of quite severe fiscal austerity – remember that was during the years of the sovereign debt crisis when public sector debt was very high – and over the next couple of years, we've probably seen even mildly stimulative policies in Euro area countries.

Leo Schulz: Alexis, are we seeing sort of a turnaround and the seesaw is kind of going to change the balance between fiscal policy and monetary policy?

Alexis Gray: No. I don’t think so. Although fiscal policy is not as tight as it was before, at the moment we still see, and we expect to continue seeing, that monetary policy is doing most of the heavy lifting. So the key takeaway for investors is that despite this fear about rising interest rates, I really doubt that interest rates will return to pre-crisis levels.

Leo Schulz: Change is happening, but monetary policy is likely to remain supportive for quite some time to come, while the effects of fiscal policy are likely to be relatively moderate. Peter, Alexis, thank you both very much.

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