Despite inflation discussion, no surge expected says Axa IM’s Chris Iggo

Chris Iggo, CIO of Fixed Income at AXA IM, has addressed the theme of inflation in light of discussions around the possibility of monetary policy changes by central banks.

Even central bankers are not safe

Recently there has been a lot of talk about central bank independence being compromised.

In Japan, the new government under Prime Minister Abe is in the process of replacing the leadership of the BoJ after already pressuring a more expansionary monetary policy. In the UK a new central bank governor has been appointed by the government and the choice of Mark Carney has certainly led to speculation of changes to the Bank of England ‘s monetary policy strategy.

Even where there has not been explicit political pressure on the central bank, the financial crisis and the lack of growth has led to shifts in the reaction function of central bankers. The Fed is still expanding its balance sheet and the ECB has been more active in both bank and sovereign funding in the last three years.

Whether or not the textbook view of a central bank 100% focussed on managing inflationary expectations was ever the reality, it is clear that in recent years central banking has drifted away from that. For all the right reasons, monetary policy has been focussed on providing sufficient liquidity to keep the financial markets open, to make government debt servicing cheaper and to incentivise investors to allocate to corporate securities.

With this has come a lot of political expectation. Central bankers were not shy about claiming responsibility for the “great moderation” in inflation that happened over the last thirty years and so have little choice but to try to meet expectations of using monetary policy to deliver the world economy from the brink of depression today.

Hence unconventional monetary policies. Hence the continuing emphasis on the role of monetary policy in boosting economic growth. Hence the strong message from central bankers – with Draghi reaffirming this on Thursday – that no tightening of monetary policy is on the horizon.

Flexible inflation targeting – doesn’t it just mean higher inflation?

It makes sense that if central bankers have somehow shifted their emphasis then future inflation outcomes should be more uncertain.

The Bank of England has generally overshot its inflation target and the suggestion from governor-in-waiting Carney is that he may favour even more flexibility in managing the inflation target going forward. Instead of always suggesting that inflation will come back to the 2% target over the 2-year forecast horizon, future policy messaging may be that policy will allow a longer time horizon for inflation to adjust if other macro targets – growth and employment – are not being met. If the economy is operating at a level below full capacity with the unemployment rate above its natural rate, then monetary policy will not simply be tightened if inflation is overshooting some desired level.

Thus over most time horizons, while the central tendency for inflationary expectations may still be represented by official or implicit inflation targets, the range of inflation expectations will be skewed to the upside. Policy may well be still focussed on delivering 2% inflation at some point in the future – and central bankers will hope this message will be credible enough to keep inflationary expectations anchored – the likelihood is that average inflation will be higher as policy will tolerate inflation above target for longer than under the current regime.

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