Central Banks Struggle for Exit as Recovery Weakens
The world’s major central banks are having a tough time exiting crisis mode, prolonging aid or raising the prospect of reviving unconventional stimulus tools as the global recovery loses momentum.
The U.S. Federal Reserve said Sept. 21 it’s prepared to ease monetary policy further if needed and has highlighted asset purchases as an option. The Bank of England yesterday signaled policy makers are moving closer to adding stimulus. The European Central Bank extended liquidity support for banks into 2011 on Sept. 2.
The stances are a turnabout from early 2010, before Greece’s debt crisis came to a head in May, when central bankers were halting stimulus or discussing how to tighten policy. The recovery from the worst global downturn since World War II is proving weaker than projected, the Organization for Economic Cooperation and Development said this month.
“Economies are slowing, so the central banks will have to do an awful lot more to help them,” said Stuart Thomson, international fixed income fund manager at Glasgow-based Ignis Asset Management, which manages about 70 billion pounds ($110 billion). “It’s a done deal that more quantitative easing is coming and then the only question now is when we get it.”
Also on Sept. 16, the Swiss National Bank kept borrowing costs close to zero while lowering its inflation forecast.
Top Bank of Japan officials yesterday flagged rising risks to the nation’s growth as the yen climbed in the aftermath of the Fed’s statement. The remarks came a week after Japan sold yen for the first time in six years in response to a strengthening currency that threatened to derail the economy’s recovery.
Recent data suggest the economy of the Group of Seven nations could grow at an annualized rate of about 1.5 percent in the second half, below the 1.7 percent previously envisaged and the 3 percent rate of the first six months of the year, the Paris-based OECD said Sept. 9. The International Monetary Fund said in July, while raising its global growth forecast for this year, that “downside risks have risen sharply.”
Central banks are weighing the potential inflationary costs of further stimulus against the prospect of deflation, or a broad-based decline in prices, and may see benefits from more aid, said Jay Bryson, global economist at Wells Fargo Securities LLC in Charlotte, North Carolina.
The risk “of not putting too much stimulus into the economy is potentially deflation, and that’s not a good thing to do,” said Bryson, a former Fed economist. “On the other hand, what happens if you overstimulate the economy? You may end up down the line with a little bit higher inflation rate than you would like, but we can deal with that later.”
The Fed’s Open Market Committee, which met this week in Washington, moved closer to a second wave of unconventional monetary easing after purchasing $1.75 trillion of mortgage debt and Treasuries from December 2008 through March 2010 and deciding in August to stop letting its balance sheet shrink.
The U.S. central bank said in a statement that it’s “prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate” for stable prices. Growth “is likely to be modest in the near term,” the Fed said.
In February, the Fed raised the discount rate, charged on direct loans to commercial banks, to 0.75 percent from 0.50 percent, while keeping the benchmark overnight lending rate target close to zero. Fed Chairman Ben S. Bernanke testified before Congress in March on how the Fed would pare back record stimulus, and his July written testimony on monetary policy devoted more space to the Fed’s exit strategy than what the central bank could do to boost growth and employment.
The Bank of England purchased 200 billion pounds of bonds from March 2009 through January 2010. Mervyn King, the U.K. central bank’s governor, said in a June speech that officials would probably raise interest rates before selling bonds when they decide to remove stimulus in the economy.
Now the Bank of England, which has held its benchmark rate at a record-low 0.5 percent since March 2009, is signaling that it’s contemplating further asset purchases.
“Most” officials see the central bank’s current stance as “appropriate,” and for some members, “the probability that further action would become necessary to stimulate the economy and keep inflation on track to hit the target in the medium term had increased,” according to minutes of the Sept. 9 meeting released by the central bank yesterday.
Opinions aren’t unanimous among policy makers. Thomas Hoenig, president of the Kansas City Fed bank, dissented from the Fed’s decision for a record-tying sixth straight time and has been calling for an increase in interest rates. Andrew Sentance pushed for a fourth month to raise the Bank of England’s benchmark rate “gradually,” minutes said.
Still, the signals from the Fed and Bank of England leave central banks in Canada, Australia and Norway with little company in tightening credit among developed countries.
The ECB this month extended unlimited liquidity support for banks in its one-week, one-month and three-month refinancing operations into 2011 to give them more time to patch up their balance sheets as the euro-area recovery shows signs of weakening. Growth in the 16-nation currency region may slow from 1 percent in the second quarter to 0.3 percent in the three months through December, the European Commission forecast Sep. 13.
In April, the ECB tightened the terms of its three-month market operations by returning to the pre-crisis practice of offering the funds at a variable rate. The bank started pulling back stimulus in December, when it stopped offering 12-month loans and announced that it would terminate its six-month loans in March.
The escalation of Europe’s fiscal crisis in May forced the ECB to halt its withdrawal of support for the region’s banks. While the ECB no longer offers firms 12-month loans, the debt crisis has prompted it to reintroduce unlimited lending in its three- and six-month refinancing operations and to start buying the bonds of big-deficit governments.
Bond purchases have risen in the past three weeks to 323 million euros ($432 million) as spreads between Irish and Portuguese 10-year bonds and their German equivalent rose to record highs. Since the program’s inception in May, the ECB has bought 61.5 billion euros of government debt.
“Central banks are still leaning in the direction of unconventional measures,” said Ken Wattret, chief European economist at BNP Paribas in London.
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