What does the chart show? 

The chart shows the headline interest rates at central banks around the world over the last five years. The recent surge in energy and food prices triggered by Russia’s invasion of Ukraine was an exogenous shock that could not have been foreseen, but central banks misjudged the broadening and persistence of the inflation surge that started long before then, and now well evident. Policy catch-up is underway, with many central banks around the world shifting rapidly to aggressive tightening. In contrast, Asia is not suffering the same inflationary problems as the US and Europe. In China, inflation is not as high, and their central bank is easing policy. The People’s Bank of China (PBOC) has shifted from policy tightening towards stimulus, with cuts in its lending rate and injections of liquidity. Meanwhile, the Bank of Japan (BOJ) is maintaining interest rates of -0.1% and has reaffirmed its commitment to yield curve control by purchasing Japanese Government Bond’s (JGB) without limit to keep 10-year yields around 0%. 

Why is this important? 

The Fed has led the way, with a rate rise of 50bps in May (in line with expectations), the first of this size since 2000, and signalling two further 50bps rises in its next two policy meetings, with more rises to follow. It has also brought forward its plans to remove liquidity from the financial system, with quantitative tightening beginning in June at the rate of $47.5bn per month, before moving to $95bn per month within three months. With the Fed’s much more aggressive tightening than other central banks and rapidly rising interest rate differentials in favour of the dollar, further rises cannot be ruled out. The European Central Bank (ECB) has been later to respond to the inflationary surge and has also become increasingly hawkish recently, signalling an end to its huge asset purchase programme along with its first interest rate rise in July, and an end to negative policy rates during the third quarter. While central bank policy tightening is now well flagged and at least in part discounted by markets, the bulk of the tightening probably lies ahead, in particular the withdrawal of liquidity is only now beginning. Despite the resurgence and spread of Covid-19 in China, there could be opportunities that lie beyond these short-term challenges. The PBOC is not under as much pressure to combat red-hot inflation by raising interest rates and are instead in a position where they can cut rates to help stimulate growth. This is another good example of the opportunity in active management, if we’re selective in terms of timing and positioning, then we could take advantage of any attractive entry points that may present themselves.