Where next for monetary policy?

Financial markets were unsettled towards the end of June by speculation that leading central banks might be poised to end their ultra-loose monetary policy. Following the US Federal Reserve’s (Fed’s) third interest rate increase in six months, investors reacted strongly to European Central Bank (ECB) President Mario Draghi’s view that deflationary forces are being replaced by reflationary influences in the eurozone.
The ECB upgraded its economic growth predictions for the euro area from to 1.9% in 2017, and 1.8% in 2018. The eurozone’s labour market continued to strengthen during the first three months of 2017 and its economy expanded at a quarterly rate of 0.6%. France’s new President Emmanuel Macron won a clear Parliamentary majority in June; the CAC 40 Index declined by 3.1%, while the Dax Index fell by 2.3%.
As expected, the Fed increased its key interest rate by 0.25 percentage points during June. The central bank plans to begin paring back its balance sheet later this year. The US economy posted a faster rate of expansion than originally calculated during the first quarter of 2017, growing at an annualised rate of 1.4% compared with an initial estimate of 1.2%. The financials sector was cheered by the Fed’s confirmation that the 34 largest US banks have sufficient capital to cope with a range of severe financial shocks. The Dow Jones Industrial Average Index rose by 1.6% over June as a whole.
In the UK, investors were rattled as the snap General Election resulted in a hung Parliament that intensified concerns over the UK’s Brexit prospects. Uncertainties were compounded by an increasingly hawkish tone from the Bank of England; although base rate remained unchanged at the Monetary Policy Committee’s (MPC’s) June meeting, three members of the MPC voted in favour of an increase. Consumer price inflation rose to 2.9% during May, moving close to a four-year high; however, wage growth is not keeping pace with the rising cost of living. During June, the FTSE 100 Index fell by 2.8%.
Japan’s economy posted slower-than-expected growth during the first quarter of 2017, expanding at an annualised rate of only 1%. Bank of Japan (BoJ) policymakers retained their monetary policy stance in June; core inflation remains subdued at 0.4% year on year, although it is expected to rise slowly towards its 2% target. The Nikkei 225 Index rose by 1.9% during June.