MNI INTERVIEW: Central Bank Credibility To Be Tested In 2024

Central banks across the developed world will have their credibility and communications tested over 2024 as they decide between continuing to fight inflation by maintaining elevated interest rates or easing as economic growth slows, a former Reserve Bank of New Zealand economist told MNI.

“This is really the first test of what wins out and central bank credibility,” said Leo Krippner, research fellow at the Singapore Management University who served as a senior advisor to the RBNZ until 2019. “Do central banks keep the same mindset of the last two, three decades, and say ‘no we target inflation first and foremost’ and whatever needs to happen in the economy is just how it is? The alternative is they give support to the economy and assume inflation will come back down without actually seeing it within target.”

Central banks will place a great deal of faith within their forecasts should they choose the latter, he added, noting failure risked either rates staying elevated for longer, or further hikes should inflation resume rising.

Recent decisions by the RBNZ and Reserve Bank of Australia, which took very different approaches towards future rate moves despite similar, slower economic data, illustrated how central banks will struggle to communicate their intentions as they enter this “no man’s land,” he added.

The RBNZ noted it was nowhere near rate cuts, despite lowering its peak official cash rate forecast in February when the monetary policy committee decided to hold at 5.5%. (See MNI RBNZ WATCH: RBNZ Leaves Rates On Hold, Downgrades OCR Peak) RBA Governor Michele Bullock, meanwhile, said nothing was ruled in or out following the board's decision to hold the cash rate at 4.35%. (See MNI RBA WATCH: Bullock Stresses Data, Switches To Neutral Tone)

Elevated inflation as economic growth stalls present a real risk to central banks’ strategies, Krippner argued, noting most western economies faced a similar dilemma. "The first choice of central banks will be to signal they want to keep rates higher for longer," he added. "Personally, I don't think higher rates isn't something that should be dismissed, there's a material probability of that. But in terms of the dichotomy that central banks face, I believe they will concentrate more on inflation and that would mean rates higher for longer."

MARKET DISCONNECT

Krippner said interest-rate term structure and the profile of the yield curve showed markets had factored in relatively quick monetary easing. “I think that might ultimately be preemptive of what might possibly happen,” he added.

While U.S. dollar markets had priced in almost six rate cuts at the start of the year, they had reverted to about three following Federal Reserve signalling, he added.

"Markets all seem to like getting ahead of the central banks," he added. "They all want to get on board and long bonds, but they'll only perform well should more easing occur than expected and there's already a lot of easing priced in."

He said central banks may not ease enough for bonds to outperform.