Central banks have a variety of mechanisms to influence the economy. None is more visible than interest rates. When interest rates are at all time lows in most major economies what is a central bank to do?
Low interest rates around the globe have forced central banks to adopt quantitive easing to boost growth. Increasing the money supply to ease lending by financial institutions and fulfil their employment, price stability and growth targets. Not all central banks behave in the same way as they are addressing different market conditions. Before June most of the major central banks were working towards maintaining the current stimulus or like the BoE and Japan thinking about expanding the size of the program. On June X the US Federal reserve announced its plans to start scaling down its bond-buying program.
Central bank reactions have been varied. These is a sample of the major central banks current policies around the world:
Bank of England – Carney gets unanimous vote
Incoming Governor Mark Carney can add to his short term wins that of reaching consensus in his first Monetary Policy Committee meeting. The MPC voted 9–0 to keep the UK Bank Rate at 0.5% and to maintain the asset purchases to 375 billion pounds. The decisions had been announced on his first week as the head of the BoE on July 4th, but with the release of the minutes on July 13th the market had further insight into how the meeting transpired.
Reaching consensus was important. It is of note that known doves Paul Fisher and David Miles who had previously voted alongside Sir Mervyn King on his 5 unsuccessful attempts to increase the size of the stimulus joined Carney on his first vote. Although the vote was unanimous there are still two factions within the BoE. There are MPC members that wish the size of the stimulus to remain unchanged as a change now might be premature. On the other side are those members that argue that it should be increased as the UK economy is still not growing at a fast enough pace. This group is also open to investigating other options such as diversifying the assets that are part of the stimulus. In August the Committee should have a clearer idea on this subject as well as the merits of forward guidance.
US Federal Reserve – Bernanke is not a Financial Advisor
Federal Reserve Chairman Ben Bernanke had a busy week. Testifying in front of Congress on Wednesday and the Senate on Thursday the market did not get the clarity it needed regarding QE.
After single handedly delivering a market moving shock last month by hinting US QE could be scaled back this year he has softened his tone somewhat.
The Fed Chairman stated before his testimony that there are three reasons behind the rise in long-term Treasury yields:
– Improving US economic data
– Unwinding of risky positions
– Changing market interpretations of Fed policy
Bernanke faced with questions about where the market was headed. In the case of congress he was asked about refinancing mortgage rates. He declined to comment and excused himself as he is not a financial advisor. The senate inquired about the price of gold and the reasons behind the drop. He hinted that it could be related to investors being less worried about the economy, but he stated that he does not pretend to understand gold prices.
Bernanke’s speeches were taken as dovish, and along with the soft economic data have deflated tapering fears and depreciated the USD. Unemployment claims on Thursday were lower than expected which could reignite the QE tapering conversation if the Non-farm payroll figure on August 3rd beats expectations and lower the unemployment rate.
This week Bernanke was adamant that there is no calendar scheduled for the end of QE. It will be dictated by economic indicators. If the process is started it might be modified to ensure the economic recovery keeps gathering steam. A very noncommittal statement which has also added to the rumours that even if QE is still around for the beginning of next year, Bernanke might not be at the Fed.
Bank of Japan – Kuroda highlights Economic Recovery
Bank of Japan’s Governor Haruhiko Kuroda will go into the weekend knowing that the monetary policy that has gotten so much attention in the last 6 months will not be questioned in the upcoming G20 meeting in Russia. US Federal Reserve Chairman Ben Bernanke gave his backing on Thursday. He mentioned the current policy is not target currency weakness, but rather its focused on battling deflation. Bernanke might want to ask for a reciprocal vote of support from the BoJ as the IMF lists both Abenomics and the Fed QE exit strategy as the top three risks facing global growth alongside the Chinese economic slowdown.
Last week at the scheduled news conference following the rate announcement Gov. Kuroda upgraded its assessment of the Japanese economy. The tone was optimistic that no additional stimulus was needed as the economy was in line with projections. Inflation is the key indicator when looking at Japan. Some headway has been made in the battle against deflation, but the aggresive 2% target in two years is still fodder for internal debate within the BoJ.
The potential US Fed end of QE could make global markets look to Japan for leadership to prop up the global economy.
European Central Bank – Lower for Longer
European Central Bank President Mario Draghi has stated that the low rates will continue for an extended period. This month marks the premiere of “forward guidance” to the ECB lexicon. Gone are the days of Jean-Claude Trichet who for 8 years as president of the ECB managed to avoid giving straight answers for the most pressing questions on Europe’s economy and stressed that the ECB never “precommits” on monetary policy. Draghi on the other hand has tried different approaches. He has done the bold approach. He pledged to defend the EUR with a “whatever it takes” bravado. Optimistic with a “worst is behind us” scenario. Now he has arrived at a “forward guidance” methodology where he can reassure markets somewhat after mechanisms such as the Outright Monetary Transactions (OMT) have reduced impact due to higher yields in the US.
The current stance of the ECB is dovish. Rates have nowhere else to go after touching all-time lows. Contrasting the US economic recovery story, Europe is still facing deep unemployment, unresolved bailout concerns and political fragmentation. The central bank has not clearly outlined which economic indicators will dictate policy changes. To adopt a “forward guidance” it will need to move away from the “two pillars” approach of money supply and a range of economic indicators.
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