Draghi-King Push May Mean Bigger Step Into Zero-Rate Era
The European Central Bank and the Bank of England may drive global monetary policy deeper into the world of zero interest rates and unorthodox methods today as they seek to stimulate their flagging economies.
The ECB will take its benchmark interest rate below 1 percent for the first time, cutting it by a quarter percentage point to a record low of 0.75 percent, and reduce its deposit rate to zero, according to a Bloomberg News survey of economists. The Bank of England will raise its target for bond purchases by 50 billion pounds ($78 billion) to 375 billion pounds, another survey shows.
The moves would push JPMorgan Chase & Co.’s average interest rate for developed economies to a crisis-era low of about 0.5 percent and add to the balance sheets of major central banks, which have already swelled 40 percent in five years of global financial turmoil. The jury is out on whether the monetary medicine will work or whether policy makers will be forced to deploy further measures.
“A big part of the world economy has become fairly stagnant and so central banks are in easing mode again,” said Joseph Lupton, a global economist at JPMorgan in New York. “We’re probably at the point of diminishing returns, but it can still be argued that it helps somewhat.”
The Bank of England, which has been drawn into the scandal over Barclays Plc’s rigging of Libor rates, will announce its decision at noon in London. The ECB will follow at 1:45 p.m. in Frankfurt and President Mario Draghi holds a press conference 45 minutes later.
The Fed, which holds its benchmark rate in a range of zero to 0.25 percent, expanded an operation to lengthen the maturities of assets on its balance sheet to lower long-term market interest rates. The Bank of Japan’s key rate is at 0.1 percent and economists at UBS AG and Jefferies Japan Ltd. are among those predicting it will next week boost its asset-buying program from the current 40 trillion yen ($500 billion).
The additional stimulus almost five years since the start of the financial crisis has helped support equity and commodity markets. The MSCI World Index (MXWO) is up 8.6 percent since June 4.
Forcing central bankers’ hands is Europe’s debt crisis, which has caused the weakest patch of global growth since the end of the 2009 recession. All but three of the 26 developed economies monitored by JPMorgan will see inflation undershooting their central banks’ targets by the end of the year, according to Lupton.
ECB policy makers are meeting six days after European leaders handed respite to their stressed bond markets by addressing weaknesses in their bailout programs and trying to break a negative loop between troubled sovereigns and banks.
The political progress may encourage the ECB to build on the confidence boost by offering further support to the faltering euro-area economy. Unemployment rose to a record 11.1 percent in May and the services and manufacturing industries contracted for a fifth month in June. The 17-nation economy will shrink 0.3 percent this year, according to the European Commission.
“The economic case for easing is quite overwhelming,” said Nick Kounis, head of macro research at ABN Amro in Amsterdam. “The euro zone is in recession and contraction looks like extending into the third quarter. Most indicators are clearly consistent with monetary easing and probably further substantial monetary easing.”
Rate cuts would reduce borrowing costs for euro-area banks, which have tapped the ECB for more than 1 trillion euros ($1.26 trillion) in three-year loans.
Taking the deposit rate to zero from 0.25 percent may also encourage banks to lend rather than parking excess cash with the ECB overnight. Around 800 billion euros is currently being deposited with the ECB each day.
At the same time, a deposit rate cut would lower market interest rates and potentially hurt banks’ profitability, which could discouraging them from lending. The euro overnight index average, or Eonia, stood at 0.33 percent yesterday.
The ECB has resisted cutting its key rate below 1 percent or joining its U.S. and British counterparts in pursuing quantitative easing, preferring instead to offer banks liquidity.
The lower its rates go, the more the ECB may have to consider using asset purchases to ease policy further, said Joachim Fels, chief economist at Morgan Stanley in London.
“While ECB QE is not on the cards yet, it might become a market focus over the next few months if the recession persists and the ECB starts to worry about potential deflationary risks for the euro area as a whole,” Fels said.
Already plagued by a repeat recession, the Bank of England may bolster its asset-purchase program after Governor Mervyn King said last week that Europe’s debt turmoil has stoked uncertainty and tightened credit availability.
U.K. mortgage approvals fell in May and construction ouput contracted at the fastest pace in 2 1/2 years. Inflation slowed to 2.8 percent in May, the closest to the central bank’s 2 percent target since November 2009. The U.K. economy will expand just 0.1 percent this year, according to the British Chambers of Commerce.
Temptation to Act
While 30 of 41 economists in the Bloomberg survey predict a 50 billion-pound increase in the Bank of England’s asset- purchase target, eight anticipate it will add 75 billion pounds. The bank will leave its key rate at a record low of 0.5 percent, according to 49 of 50 economists in a separate survey.
“Given how inadequate growth is perceived to have been, the temptation to do a bit more will be there,” said Neville Hill, an economist at Credit Suisse Group AG in London.
The central bank is taking other steps to aid growth, including establishing a program to boost credit to companies and households and activating a sterling liquidity facility for banks.
It remains to be seen whether the additional measures can bolster growth.
The Bank for International Settlements said last month that central banks are confronting the limits of their ability to aid recoveries and risk creating longer-term problems for their economies.
Draghi last month also questioned the effectiveness of cutting ECB rates, arguing that “price signals” have a “relatively limited immediate effect” amid financial-market tensions. By contrast, King said on June 14 that “the view that further monetary stimulus is, in present conditions, simply ‘pushing on a string’ is, in my view too pessimistic.”
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