(MENAFN - Arab Times) KFH-Research expected in a report it had issued that inflation rates will continue to drop in parallel with the slowdown in economy activities in 2013. All eyes are on central banks in controlling the monetary supply to face a potential increase in inflation rates due to doubts that food and oil prices will not increase. In order to lower interest rates to trigger economic growth, no actions must be taken now. This approach will evade a second wave of financial crisis that is similar to the crisis that hit the world in 2008 and 2009.
In addition, the report mentioned that interest rates in the United States and the GCC region are not expected to increase until 2015. It is expected that the European Central Bank will lower the interest rate again during Q1 of this year.
According to the IMF, inflation is expected to continue moderating going forward in tandem with slowdown in global economic activities and lower commodity prices. Core inflation has also generally been subdued and steady in advanced economies at rates below target and has declined in emerging economies.
For 2012, consumer prices in advanced economies are expected to decline to 1.6% from 1.9% recorded in 2011 and to soften further to 1.6% in 2013. In emerging market and developing economies, headline inflation is projected to move broadly sideways, to average at 6.1% this year and 5.8% next year. At the current juncture, ample slack in many advanced economies and less pressure on capacity in emerging economies are likely to lead to further declines in inflation. The forecast is also based on assumption of stable or declining commodity prices as predicted by futures markets.
Nevertheless, upside risks to inflation persists. Swollen central bank balance sheets would ultimately lead to a significant rise of the money supply and thus inflation. Central banks though have sufficient tools to absorb the liquidity they create to forestall future inflation but will need to remain vigilant to such risks as economic slack diminishes. Furthermore, a reversal of food price increases is by no means guaranteed, partly due to low buffer stocks. Another important concern is the possibility of a sharp spike in oil prices triggered by geopolitical tensions.
Global Fiscal Monetary Policy Updates and Outlook
Fiscal consolidation in advanced economies should proceed in a sustained and gradual manner, while central banks should stand ready to do more if needed. Fiscal policy should adhere to cyclically-adjusted targets unless activity falls significantly short of projections, in which case adjustment should be smoothed in countries that can afford it. In the US, the imperatives are to agree to and implement a credible medium-term fiscal adjustment roadmap. In Japan, the plan should be strengthened considerably, notwithstanding the recent approval of a timetable for consumption tax increase. Central banks should continue managing downside risks to growth while addressing factors that hinder the effectiveness of monetary transmission.
Meanwhile, many central banks around the world have already responded to slowing economic activities by cutting interest rates aggressively to stir economic growth, avoiding the second wave of global crisis in 2008-09. Currently, most of the central banks are maintaining its monetary policy stance and adopting a wait-and-see approach, carefully assessing external risks before taking any decisive action. We expect a continued divergence of monetary policy movements, determined in individual countries by a balance of risks between growth and inflation.
For those with low public debt or pursuing policies to move further from externally- to domestically-driven growth, placing consolidation on hold is appropriate in light of the weaker outlook. Others should rebuild fiscal room for manoeuvre over time. Where inflation is tame, monetary policy can remain on hold or be eased. However, monetary policy needs to be more cautious where inflationary pressures remain elevated and should be supported by macro-prudential measures where credit growth and real estate prices are high.
As widely expected, the US Federal Reserve (Fed) offered no change in policy at the October 2012 meeting, and made very minor tweaks to the statement. The Fed remained committed on its bond-buying programme and its plan to keep short-term interest rates near zero until mid-2015. The open-endedness of the third round of quantitative easing programme (QE3) and the tone of the FOMC's latest policy statement indicate that the Fed would do anything to boost growth, improve financial conditions and employment. Additional Treasury bond purchases through money printing could be launched next year along with mortgage-bond purchases if the economy doesn't pick up, especially credit growth and housing market. The Fed plans to do its next major evaluation of its bond-buying programs at its final meeting of the year on 11-12 December 2012. Policy makers are still gathering evidence on whether their programs are working.
Meanwhile, the European Central Bank (ECB) also resisted from cutting rates after building expectations that it will do "whatever that was needed" to save the euro. The board decided to maintain its lending rate at 0.75% during its MPC meeting on 6 December 2012 after cutting both rates by 25 basis points in the last meeting in July 2012. The Bank resisted calls for an interest rate cut as the 17-nation currency bloc battles economic recession, public spending cuts and weak growth prospects. We expect another 25bps cut to 0.50% in early 2013. Similarly, the Bank of England's (BOE) monetary policy committee voted to keep its main interest rate at a record low of 0.5% and maintain the size of the asset purchase programme, known as quantitative easing, at GBP375bln during its MPC meeting on 5 December 2012. Unlike the ECB, the BOE is expected to keep the interest rates on hold until the first quarter of 2014.
In Japan, the cabinet announced that it would tap reserve funds to spend JPY880.0bln (USD10.7bln) on a variety of measures amidst the political pressure for further monetary easing. Interest rates have been at 0.0% growth since 2012. The central bank set a price goal of 1.0% in February 2012 and has pledged "aggressive" easing until the target is in sight.
In the event that global economic growth worsens more than expected, i.e. conditions in the euro-area deteriorates, the emerging markets has more room to cushion the blow, both from monetary and fiscal stance. However, we believe that officials will rely more on fiscal measures this time around as monetary policy across emerging markets and Asia are currently more accommodative than it was before Lehman Brothers collapsed. Hence, we do not foresee any aggressive interest rate cuts in the first half of 2013.
Further easing may be warranted where inflation is well within comfort zones and monetary stances are closer to neutral. On the other hand, still-high inflation countries (such as India and Vietnam) and strong credit growth may limit the room for policy manoeuvre in some economies.
Meanwhile, pegging of the GCC currencies to the US dollar inhibits flexibility of the interest rate movements in the GCC. We forecast policy rates in the GCC countries will remain untouched until 2015, in line with the Federal Reserve. We also believe that the GCC will remain committed in pegging its currencies against the US dollar, as it provides stability and the authorities seem not keen in changing the system.