- Bank for International Settlements meets in Basel on Sunday
- Brexit shock may prompt more stimulus, push back recovery
Listen at the doors of two major gatherings of the world’s central bankers in Switzerland and Portugal next week, and one might hear little but the sound of forecasts being shredded.
The world’s monetary guardians will convene at the Bank for International Settlements’ annual meeting in Basel over the weekend, and at the European Central Bank’s yearly policy forum in Portugal from Monday. At each event they may consider how, after years of striving to heal their economies, and with nascent signs of success in the halting normalization of U.S. monetary policy and a gradual pickup of European credit, they’ve been set back by U.K.’s vote to leave the European Union.
Policy makers who acted promptly on Friday to help quell market turmoil are likely to turn to assessing the impact of the British decision on growth and inflation prospects for the EU and beyond. In calibrating a response, they’ll be mindful that monetary policy is already severely stretched after almost a decade of financial turbulence.
Central bankers “will instinctively understand that Brexit is a negative for the global economic outlook,” Marchel Alexandrovich, senior European economist at Jefferies International Ltd. in London, said by phone. “Now it becomes a European issue, for banks and insurance companies. Two months ago we were hoping that the U.S. Federal Reserve would raise rates, and there’d be higher yields at the end of the year. We’re in for a very long and uncertain road.”
Investors and policy makers will have to wait for the U.K.’s decision to filter through into economic data -- first through sentiment indicators and then hard output figures. The European Commission’s confidence gauge for the euro area on June 29 will likely be too soon to capture any changes. Smaller indicators, such as the Sentix index due on July 4, have a short-enough lag to reflect some of the impact.
There is potential for significant reversals. Indicators including the ZEW investor expectations surveys for the euro area and Germany’s influential Ifo Index of business confidence rose in the run up to the vote.
The BIS -- an institution that has warned repeatedly about the dangers of overburdening monetary policy -- may find itself hosting officials concerned that their initial pledges of liquidity need to be followed up with stronger action. The man they’ll most want to talk to, unless turmoil at home keeps him away, is Bank of England Governor Mark Carney.
“Governors endorsed the contingency measures put in place by the Bank of England and emphasized the preparedness of central banks to support the proper functioning of financial markets,” Bank of Mexico Governor Agustin Carstens said by e-mail on Saturday. Carstens commented as the chairman of the Global Economy Meeting, which is the principal discussion forum for central bank chiefs during the regular BIS bimonthly meetings.
Analysts including Gilles Moec, chief European economist at Bank of America Merrill Lynch, now expect the BOE to cut its key interest rate to zero in July from the current record-low 0.5 percent, and expand its quantitative easing program by 50 billion pounds from August.
For the U.S., the Brexit saga has explicitly impacted the Fed’s plans to move interest rates from crisis-era lows. Chair Janet Yellen said this month that the impending vote played a role in the decision not to tighten.
Life at the ECB will scarcely be easier in coming days. Its annual forum in the Portuguese resort of Sintra is intended as an academic getaway, far from the pressures of markets, but there’s likely to be no escape from Brexit. Bond spreads between euro-area nations widened on Friday as investors shunned higher yielding debt such as Spain’s in favor of havens such as Germany.
The ECB this month forecast euro-area economic growth of 1.6 percent in 2016 and 1.7 percent in each of the following two years. It sees inflation -- at minus 0.1 percent in May -- rising to 1.6 percent by 2018. Updated calculations to be published in September might not look so rosy. The Governing Council is due to hold its next non-monetary policy meeting on July 6, and a rate-setting session is scheduled for July 21.
In the near-term, the expected drop in U.K. demand for euro-area exports could, along with the confidence effects on top, translate into a 0.3 percent reduction of the bloc’s gross domestic product, according to estimates published by Nicola Mai, an analyst at Pacific Investment Management Co. on Saturday.
That’s “modest but not irrelevant for an economy were underlying growth is close to 1.25 percent,” Mai wrote. “This additional shock to an already fragile recovery means that the ECB may need to add yet again to its already aggressive quantitative easing program.”
According to Jefferies’ Alexandrovich, the Frankfurt-based central bank may be able to contain any bond-market turmoil in Europe simply by picking up the pace of its asset-buying program, currently 80 billion euros ($89 billion) a month. Beyond that, it may have little room left to ease policy.
Moreover, the U.K.’s jettisoning of the EU might engender a fundamental doubt about the future of the bloc, and by extension the euro, according to Megan Greene, chief economist at Manulife Asset Management LLC in Boston. In that case, central bankers can do little to address what is a political problem.
“This will provide a real confidence-channel headwind in the EU, and over the medium term the threat is much bigger,” Greene said in a phone interview. “There will be some soul searching about what the EU needs to change.”