The impact of monetary policy responses finally starting to show

With Daniel Murray hosting the podcast this week, Stefan Gerlach joins us to talk about global growth, evolving monetary policy and the potential risks on the road ahead as central bankers attempt to navigate ongoing economic uncertainty.

In the latest episode of Beyond the Benchmark Daniel Murray, EFG’s deputy CIO and global head of research was joined by Stefan Gerlach, EFG’s chief economist. Conversation began with Stefan discussing economic growth prospects. While there has been a dramatic monetary tightening, the policy effect on the economy generally lags by around four quarters, meaning that it is too early to tell if it has started to bite on the economy yet. There is however a worry that the contractionary impact from monetary tightening may have been dwarfed by more immediate effects which have boosted the economy, such as the China reopening and lower energy prices.

One of the areas that was identified as a good indicator to see the effect of higher interest rates is the housing market. Daniel highlighted that the last time that there was a big issue in the housing market it was associated with the global financial crisis (GFC), but Stefan is not worried about the possibility of a repeat scenario this time round. Banks and financial institutions are now in a better position to avoid an “economic heart attack”, with the financial system better capitalised and the quality of loans extended seems to have been much more carefully monitored in this cycle than during 2008.

Following the GFC and also during the Covid crisis, central banks greatly expanded their balance sheets, but now this is starting to be reversed, albeit slowly. While central banks are likely to want to act in a way to minimise disturbances to the economy, there is still uncertainty and risk around the process. Stefan expects that even with reductions, balance sheets will remain substantially larger than they were previously due to regulatory considerations where they need to have access to more liquid funds as well as a growing demand for currency in bank notes.

A key focal point for markets of late has been where the Federal Reserve’s terminal interest rate will end up. Market sentiment has been very brittle recently, reacting very strongly to individual data points, and it also appears that the Fed itself is paying close attention to individual points. Stefan sees the Fed raising rates at least two more times, possibly three, but it will be case of waiting to see what the economic data shows. Looking to the European Central Bank it could be closer to stopping sooner than its US counterpart, as the European economy has been exposed to different types of shocks, where there hasn’t been as much fiscal expansion as in the US.

To listen to the full podcast episode click here

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