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Central Banks Want World to Party On as Punch Bowl Removed

EconomyDec 15, 2017 07:10AM ET
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© Bloomberg. The European Central Bank (ECB) headquarters stands in Frankfurt, Germany, on Thursday, July 20, 2017.

(Bloomberg) -- Central bankers are gingerly trying to take away the punch bowl without interrupting the party.

Led by interest-rate increases by the Federal Reserve and the People’s Bank of China, central banks around the world shifted toward a tighter monetary stance this week. Yet the moves were either so well-telegraphed, or so tiny, and the language about future action so hedged, that there was barely a ripple in financial markets.

“They’re terrified of upsetting the markets,” said Paul Mortimer-Lee, chief market economist at BNP Paribas. So “they’re all exiting quite slowly from emergency settings” on monetary policy.

The likely result of this leisurely approach: another year of synchronized global growth in 2018. Indeed, both the Fed and the European Central Bank revised up their forecasts for the growth of their respective economies next year even as they signaled that they would be slowly scaling back the stimulus they are providing.

“The global economy is doing well,” Fed Chair Janet Yellen told reporters on Wednesday after the U.S. central bank raised interest rates for the third time this year. “We’re in a synchronized expansion. This is the first time in many years that we’ve seen this.”

PBOC’s Surprise

While the Fed’s rise had been widely anticipated by investors, Thursday’s move by the PBOC was a surprise. Yet the move was so small -- only five basis points -- that the markets took it in stride.

“The central bank does not want to jeopardize the market with an aggressive hike,” said Raymond Yeung, chief greater China economist at Australia & New Zealand Banking Group Ltd., although the move “does indicate the tightening bias of the policy makers and this stance will continue in 2018.”

Sun Guofeng, director of the PBOC’s financial research institute, said in a recent speech that emerging market economies should also start monetary policy normalization and exit the easing measures that were put into place to address the global financial crisis.

Mexico’s central bank raised its benchmark interest rate for the first time since June on Thursday, lifting borrowing costs 25 basis points to 7.25 percent in a split vote that saw one board member favoring a 50 basis-point hike.

Turkey’s central bank raised one of its main interest rates by less than expected and vowed to keep policy tight until the inflation outlook improves. The move sent the lira sliding.

What Our Economists Say ...

Improving growth prospects, amid subdued inflation expectations, are permitting central bankers to proceed with caution as they normalize monetary policy. What policy makers need to admit is that they have underestimated the amount of lingering slack in the world’s largest economies, which means tightening will need to remain well communicated and measured through 2018.

-- Michael McDonough, Bloomberg Economics

In spite of the global upswing, major central banks have moved slowly to reduce stimulus because inflation remains muted and below their targets.

While ECB President Mario Draghi said on Thursday that he’s grown more confident that inflation will eventually rise to the central bank’s goal, the ECB’s own staff forecast doesn’t even see that happening by 2020.

The euro-area’s monetary authority, which has an inflation target of just under 2 percent, on Thursday reaffirmed its plan to halve its asset purchases to 30 billion euros ($35 billion) a month starting in January and continue for at least nine months until the end of September.

The Bank of Japan is one notable outlier, with officials keen to avoid any inkling of a move away from their unprecedented stimulus. While a new dissenter on the board calling for more stimulus has prompted the BOJ to adjust its communications to flag risks of additional easing, it’s wrong to interpret such comments as a signal of an earlier policy exit, according to people familiar with the central bank’s discussions.

A different story unfolded at Russia’s central bank, which unexpectedly accelerated its pace of monetary easing on Friday with a 50 basis-point rate cut. It said oil-production curbs have reduced inflationary risks.

Central bankers around the world are also wary of getting too far ahead of their counterparts in tightening policy out of fear that could boomerang on them by spurring a steep rise in their currencies -- a rise that would dampen both economic growth and inflation.

Currency Risk

Norway’s central bank got a taste of that on Thursday, as the krone climbed more than 1 percent against the euro after policy makers signaled they may start raising interest rates earlier than indicated in the past.

Mindful of the potential fallout in the foreign exchange market, Swiss National Bank President Thomas Jordan said on Thursday his institution was in “no rush at all” to normalize policy even as it forecast that inflation will breach its 2 percent target in 2020.

The Bank of England also seems to be in no hurry to tighten policy further after raising rates in November for the first time in a decade. The Monetary Policy Committee held its key rate unchanged on Thursday while reiterating that “further modest increases” would probably be needed over the next few years if the economy performed as expected.



Key Messages

Iceland Benchmark interest rate unchanged at 4.25% Domestic demand is growing faster than previously projected
U.S. Funds target rate raised 25bp to 1.25%-1.5% Three rate hikes expected for 2018;
Trump tax reform to have limited long-term impact
China Key rates raised 5bp (unscheduled) Small move to rein in banks’ leverage
Philippines Benchmark rate unchanged at 3% No indication of preparing to hike
Switzerland Deposit rate unchanged at -0.75% No rush at all to normalize policy
Norway Benchmark rate unchanged at 0.5% Rates likely to rise after autumn 2018
Indonesia Benchmark rate unchanged at 4.25% Easing sufficient to boost economy
Turkey Liquidity rate raised 50bp to 12.75% Smaller move than forecast disappoints traders, lira falls
U.K. Bank rate unchanged at 0.5% Modest tightening probably needed over next few years
Ukraine Key rate raised 100bp to 14.5% Unexpected rate hike to tame inflation
Euro area Deposit rate unchanged at -0.4% More confident on inflation but still below target in 2020
Mexico Key rate raised 25bp to 7.25% Balance of risks to inflation has deteriorated
Colombia Benchmark rate unchanged at 4.75% Central bank says policy rate is no longer neutral
Chile Benchmark rate unchanged at 2.5% Policy maintains moderately dovish bias
Peru Benchmark rate unchanged at 3.25% On hold as impact of previous rate cuts assessed
Russia Benchmark cut 50 basis points to 7.75% Oil-production curbs have reduced inflationary pressures

While the global monetary largesse has been slow to lift inflation, it has turbo-charged asset prices, with stock markets around the world trading at their highest levels in years.

Policy makers though played down fears that asset price bubbles were building that could threaten the financial system and the economy. “When we look at other indicators of financial stability risks, there’s nothing flashing red there or possibly even orange,” Yellen said.

While a prolonged period of very low interest rates does provide “fertile ground” for financial stability risks, there’s been no big rise in leverage, Draghi told reporters on Thursday.

Besides, the way to deal with possible threats is with macro-prudential tools such as changes in lending standards rather than with higher interest rates, he said.

That doesn’t mean there aren’t potential perils ahead. If inflation does pick up, policy makers might have to remove stimulus more quickly, jolting financial markets. And then there’s the risk that even a slow shift to tighter policy around the world could have more of a deleterious impact than expected simply because it’s concerted.

“Central banks, who’ve been pumping money into the system for the past decade or so, are going to be removing it,” said Iain Stealey, fixed-income portfolio manager at JPMorgan Asset Management in a Bloomberg Television interview on Thursday. “It’s going to be slow to start with, very gradual, but it’s going to be a real change in rhetoric.”

Central Banks Want World to Party On as Punch Bowl Removed

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