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World faces $410 billion economic shock as central banks reverse course: Report

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BUSINESS REPORTER


MUSCAT, MAY 7


The central banks of Group of Seven countries are estimated to shrink their balance sheets by around $410 billion for the remainder of 2022, a significant turnaround from the purchasing blitz enacted throughout the pandemic, according to a report by Bloomberg Economics.


This course change from an era of easy money will threaten to shock the global economy and financial markets and represents a considerable change from central bank policy during the pandemic. While G7 central bank balance sheets are expected to shrink $410 billion this year, last year they increased $2.8 trillion, hitting a total of more than $8 trillion since Covid-19 started, the report noted.


Central banks enacted unprecedented purchasing during the pandemic to prop up their economies and protect business during a Covid-19 slump. This long-term purchasing, along with continued supply chain disruption, has been a driver of soaring inflation. Now, with balance sheets set to shrink, interest rates continuing to increase, continued economic disruption caused by Russia’s invasion of Ukraine, and ongoing Covid-19 lockdown disruption in China, the global economy faces significant challenges.


To add further fuel on the fire, the US Fed is not acting alone during this tightening cycle, with other central banks also undertaking balance sheet reductions at the same time.


The new policy, known as quantitative tightening – the opposite of the quantitative easing that central banks turned to during the pandemic and the Great Recession — will likely send borrowing costs higher and dry up liquidity, Bloomberg said.


“This is a major financial shock for the world,” Alicia Garcia Herrero, chief economist for Asia Pacific at Natixis SA, who previously worked for the European Central Bank and International Monetary Fund, told Bloomberg.


“You are already seeing the consequences of tapering in reduced dollar liquidity and dollar appreciation.”


The US Fed is expected to raise its interest rate by 50 basis points at its May 3 to 4 policy meeting, with several hikes expected thereafter. Traders see about 250 basis points of tightening between now and year’s end, while officials are expecting to start trimming the balance sheet at a maximum pace of $95 billion a month, quicker than expected at the start of the year.


Others are moving in the same direction:


• The European Central Bank has signaled it will end QE in the third quarter, a timeline that is complicated by the spillover from war in Ukraine.


• The Bank of England has already started to shrink its balance sheet by ending gilt reinvestments in February. It is expected to hike rates again in May, bringing the key rate to the threshold where policy makers will weigh active sales from their asset portfolio.


“With all this central bank tightening coming into a slowdown already, it will really be all about if the central banks will tip us into recession,” Kathy Jones, chief fixed-income strategist at Charles Schwab & Co., which manages over $7 trillion in total assets, told Bloomberg.


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