Capital Markets (Inflation) vs Central Banks (Growth)

Today, and following the progress of vaccination programs in developed economies, the main concern and main argument presented by the capital markets is the expected inflation caused by the rapid recovery which in turn will force the Central Banks to raise their interest rates.

The two arguments that dominate the global financial agenda are inflation and, on the other hand, the complacency of central banks that increase liquidity with a view to the uninterrupted development of economies. More specifically:

On the one hand, the arguments, and declarations of the Central Banks, in particular the Fed and, secondly, the ECB, which aim to reassure all economic operators of their intention to pursue an expansionary monetary policy, with the main objective of developing economies not only to return to growth rates but also to regain their pre-Covid-19 growth momentum.

by Trust Economics-

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On the other hand and given that government bond yields are confidently discounting a more restrictive monetary policy in the future, they give the argument to the markets to directly challenge the arguments of the Central Banks.

The rationale of the markets is since periods of intense growth are always followed by situations where demand for products and services exceeds supply, causing the economy to overheat and, of course, inflation.

Given that a return to economic normality, combined with expansionary fiscal policy and increasing liquidity, will lead to inflation, due to this economic position the Central Banks will then have to raise their borrowing rates to cope with inflation.

For this reason, from now on, central banks will have to enter a currency policy of the type of tapering (i.e., a reduction in the volume of government bonds they buy on the secondary market) (see analysis entitled «When does Tapering start in World Bond Markets from Central Banks»).

The arguments of the Central Banks are based both on the sharp increase in public and private debt respectively and on the economic environment to date characterized by a low degree of productivity, growth, and inflation.

The arguments in favour of the markets are whether the ‘fiscal sovereignty’ of the Central Banks applies, where they alone are responsible for policy-based financing of budget deficits rather than curbing inflation.

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