Global Central Banks Diverge on Monetary Policy

The divergence in monetary policy among global central banks has become increasingly apparent.

Recently, major economies have implemented monetary policy changes at a concentrated pace, although the rhythm of these adjustments varies, and a mix of easing and tightening is evident. Preliminary statistics indicate that since August, 15 major economies have cut interest rates, while two have raised them.

At present, expectations for a rate cut by the Federal Reserve are gradually cooling, and the Bank of Japan remains "ambiguous" about the possibility of raising rates, resulting in heightened uncertainty surrounding global central bank policies. In this context, how should we view the future direction of global central bank policies? What key signals should investors pay attention to?

Simultaneous Easing and Tightening

In response to slowing economic growth and a high inflation rate receding, the "main force" of global central banks has embarked on an intensive interest rate cutting cycle this year.

In the first half of this year, central banks in Switzerland, Sweden, Canada, and others initiated the rate cut cycle; in June, the European Central Bank cut the three key rates in the Eurozone, marking its first rate cut in five years; notably, in September, the Federal Reserve dramatically lowered rates by 50 basis points, officially transitioning from a tightening cycle to an easing cycle, followed by another cut of 25 basis points in November.

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The first rate cut by the Federal Reserve in four years triggered a wave of rate cuts by central banks worldwide—emerging economies like South Korea and Thailand followed suit and joined the ranks of those cutting rates.

However, several central banks, due to their own policy considerations, have taken a contrary approach: in a bid to mitigate the effects of a prolonged negative interest rate policy, the Bank of Japan raised rates twice this year, with the second increase in July causing a massive reversal in yen arbitrage trading and further intensifying turbulence in global stock and currency markets.

Additionally, in November, the Bank of Brazil stated that inflation risks are rising and announced a 50 basis point hike to 11.25%, marking the second rate increase since September; in October, the Central Bank of Russia raised the key rate by 2 percentage points, from 19% to 21%, reaching an all-time high after multiple increases.

Regarding the current landscape of global central bank monetary policies, Cheng Shi, Chief Economist at ICBC International, told reporters that as global inflation pressures gradually ease, monetary policies of major economies are shifting from tightening to easing, with divergence in the pace of policy adjustments reflecting a characteristic of prudent weighing.

The reasons for this divergence stem from the varying macro environments and challenges faced by different economies, leading to differing policy steps. For instance, inflationary declines and economic slowdowns in Europe have occurred faster than expected, while the trends in inflation and economic slowdown in the U.S. are relatively stable.

The Divergence May Persist

"The global economy is heading towards another challenging year filled with contradictory signals and complex dynamics," predicts the European asset management giant Robeco in its recently released economic outlook for 2025.

In this intricate global environment, how will central banks position themselves? Industry insiders believe that the global monetary policy may generally enter a rate-cutting cycle, but the fundamental characteristics of its diversification won’t change significantly.

Senior researcher Liu Tao at Guangkai's Chief Industry Research Institute anticipates that the divergence in global monetary policy will likely intensify further. Specifically, in light of the currently strong economic performance and core inflation indicators in the U.S., the Federal Reserve’s stance is expected to be increasingly cautious, with a maximum of three rate cuts projected for the first half of 2025, while it may hold steady in the second half; to boost the Eurozone economy, the European Central Bank might adopt a more aggressive stance on rate cuts, resulting in relatively greater downward pressure on the euro.

"The latest policy meeting information from the Bank of Japan suggests a hawkish stance, with monetary policy trending towards tightening, as it hastens to elevate rates to neutral levels before the end of 2025." Liu Tao also warns that the reverse rate hike by the Bank of Japan could potentially trigger further turmoil in global financial markets. According to data from the Commodity Futures Trading Commission, by the fourth quarter of 2024, international investors are anticipated to significantly short the yen. Should the Bank of Japan exceed expectations with a rate hike in 2025, the yen's exchange rate and international financial markets could once again be plunged into chaos.

On the future adjustment pace of global central bank monetary policies, Cheng Shi believes it will continue to depend on each country's central bank's prudent assessment of extensive economic data, while flexibly responding within an established framework and making timely decisions.

"The complex macro environment presents heightened demands for policy formulation among major central banks, which must make difficult trade-offs between economic growth, curbing inflation, and maintaining financial stability." Cheng Shi asserts that if inflation proves to be more stubborn than expected, particularly against a backdrop of unstable global supply chains and heightened geopolitical risks, central banks worldwide may be compelled to pause rate cuts.

Global Financial Market Interconnectivity

The current interest rate environment and the direction of global central bank monetary policies profoundly influence fluctuations in financial markets.

Cheng Shi notes that the global economy and financial markets are facing the intertwined impacts of three key factors: the recalibration of the global interest rate environment, geopolitical uncertainties, and heightened exchange rate volatility.

From the perspective of major central bank monetary policy adjustments, Cheng Shi mentions that the Federal Reserve's entry into a cutting cycle is reshaping the global interest rate environment. This change affects capital flows, asset valuations, and risk appetite, encouraging capital to flow toward high-yield markets and altering the patterns of international capital flows. Furthermore, the differentiation in monetary policies and changes in interest rate differentials exacerbate exchange rate fluctuations, further impacting international capital flows and asset allocation.

"The differences in policies among different economies prompt frequent shifts of funds between pursuing high returns and seeking safe-haven assets, leading to increased market volatility, especially in emerging market economies, which often face external shocks due to weaker economic foundations, triggering financial market fluctuations. Moreover, the further divergence in global monetary policies amplifies the complexity of asynchronous economic cycles across countries." Cheng Shi states.

Cheng Shi advises that investors should maintain a degree of flexibility, closely monitor global macroeconomic data and major central bank policy changes, and adopt diversified allocation and risk management strategies to navigate potential market fluctuations, seeking opportunities for returns amidst uncertainty.