Thirty-Three Hour Race May Induce ECB Surrender
Federal Reserve Chairman Ben S. Bernanke’s push to jump-start the U.S. economy this week may weaken the dollar, forcing at least one other central bank to add its own stimulus to offset a rising exchange rate.
Bernanke is set to embark on an unprecedented second round of unconventional monetary easing, one result of which may be a cheaper dollar that boosts U.S. growth by helping American exports. A related consequence: stronger currencies abroad, threatening European and Japanese expansion.
With the major central banks all announcing decisions within 33 hours this week, fallout from the Fed could cause Bank of Japan Governor Masaaki Shirakawa to do more for his economy and Bank of England Governor Mervyn King to leave the door open to more aid. Even as European Central Bank President Jean-Claude Trichet holds the line against inflation, he may eventually change course if the euro surges, while emerging markets are already acting to restrain currencies.
“An easing in U.S. monetary policy creates pressure on the rest of the world to respond,” said Dominic Wilson, New York- based senior global economist at Goldman Sachs Group Inc. in New York. “The subsequent weakening in the dollar tends to tighten financial conditions outside the U.S.”
This week’s meetings are the greatest concentration of monetary-policy action by leading central banks since the first week of October 2008, when they met in emergency sessions to fight the global financial crisis. On that occasion, all except Japan joined an unprecedented coordinated interest-rate cut.
Now they’re invested in dealing with their own challenges. Bernanke has signaled he will restart large-scale asset purchases to help reduce unemployment and raise consumer prices. King indicated last month he ultimately may favor buying more bonds to support the U.K.’s recovery as its government aims for the biggest budget cuts since World War II.
Shirakawa and his colleagues, after vowing to keep their benchmark interest rate at “virtually zero” last month and expanding their balance sheet, plan to buy exchange-traded funds and real-estate-investment trusts to beat deflation.
Trichet nevertheless calls the ECB’s monetary-policy stance “appropriate.” The central-bank president is focusing on tougher fiscal discipline as the path to assure growth after runaway deficits led to Greece’s near-default and a continental debt crisis.
“It’s a nice idea to coordinate policy, but a central bank has to do what’s appropriate for its own economy,” said DeAnne Julius, a former Bank of England policy maker who is now chairman of Chatham House, an international research group in London. “It’s difficult to do otherwise economically and politically.”
On Nov. 3 at about 2:15 p.m. in Washington, the Fed will release its policy decision. About 18 hours later, at noon in London (8 a.m. in New York and Washington), the U.K. central bank will announce its move. The ECB will go public with its decision 45 minutes later, at 1:45 p.m. in Frankfurt (8:45 a.m. in New York). The Bank of Japan concludes its talks on Nov. 5 at about noon local time (11 p.m. in New York).
Since Bernanke said Aug. 27 that his central bank was prepared to add stimulus if necessary, the Standard & Poor’s 500 Index has gained 13 percent, while the dollar has declined about 7 percent against a basket of six currencies. This may constrain initial market reaction to a Fed announcement of so-called quantitative easing, said Keith Hembre, Minneapolis-based chief economist at U.S. Bancorp’s FAF Advisors Inc., which oversees $86 billion.
Fed Computer Model
A 1 percentage point fall in the federal funds rate results in an 8.8 percent rise in stock prices and a 2.2 percent decline in the dollar’s exchange-rate value, according to a 1999 Fed study based on an internal computer simulation. Hembre said he’d be surprised if the model has changed much since then.
“To a large degree, QE is already priced in, and there’s probably, all other things being equal, limited positive effect to come forward from actual QE,” said Hembre, a former Fed economist. “To the extent that it tends to be a more timid program than what is expected, you could potentially have some disappointment,” with initial declines in stocks and bonds.
Still, money managers at M&G Investments in London predict the rise of “currency vigilantes,” a play on “bond vigilantes,” the term coined by Edward Yardeni in 1983 for investors who would push down bond prices when they felt fiscal or monetary policies were running out of control.
“Currency vigilantes punish those central banks who print too much money by weakening their currency,” said Michael Riddell, a fund manager who helps M&G oversee about 178 billion pounds ($286 billion). “Over the longer-term, we’re bearish on the dollar and sterling.”
The Fed will pledge this week to buy assets of $500 billion or more, according to 29 of 56 economists surveyed by Bloomberg News last week, while another seven predicted $50 billion to $100 billion in monthly purchases without a specified total. Estimates for the ultimate size of the program include $1 trillion by BofA-Merrill Lynch Global Research and $2 trillion by Goldman Sachs.
Purchases of $500 billion would add as much stimulus as reducing the Fed’s benchmark rate by 0.5 to 0.75 percentage point, New York Fed President William Dudley said in an Oct. 1 speech.
Some companies in the U.S. and U.K. stand to gain from monetary stimulus and weaker currencies. Caterpillar Inc., the world’s largest maker of construction and mining equipment, predicts about a one-third increase in U.S. new-home starts next year partly because of Fed easing, the Peoria, Illinois-based company said in an Oct. 21 statement.
In the U.K., GlaxoSmithKline Plc, the country’s biggest drugmaker, gets 93 percent of its revenue outside its home country and benefited in the third quarter from exchange rates, the Brentford, England-based company said Oct. 21.
U.S. and U.K. manufacturing expanded more than forecast in October, reports showed today. The Institute for Supply Management’s factory index increased to 56.9, the highest since May, from 54.4, the Tempe, Arizona-based group said. In the U.K., a gauge based on a survey of companies by Markit Economics and the Chartered Institute of Purchasing and Supply rose to 54.9 from 53.5 in September.
The risk of the ECB’s tightening bias is that a stronger euro threatens exports, which have led the region’s recovery, as well as the ability of so-called peripheral economies such as Greece to escape deflation. The single currency has gained about 7 percent against the dollar since mid-September. Goldman Sachs predicts it will rise to $1.55 in a year from $1.39 at 4:23 p.m. in New York.
Every 10 percent gain in the euro on a trade-weighted basis reduces GDP growth by 0.8 percentage point, while also lopping about 11 percent off European corporate earnings, according to an analysis by Credit Suisse AG strategists last month. That leaves businesses including Paris-based LVMH Moet Hennessy Louis Vuitton SA, the world’s biggest luxury-goods maker, and Siemens AG of Munich, Europe’s largest engineering company, vulnerable to a stronger euro, they said.
A continued advance may ultimately force the ECB to follow the Fed and add more stimulus, said Stephane Deo, chief European economist at UBS AG in London. The ECB may broaden the collateral it accepts for loans or even cut its benchmark interest rate from 1 percent, he said, adding that there’s a “low probability” of more asset purchases.
“The ECB will follow suit, in one way or another, in order to keep the euro appreciation at bay,” Deo said. Nobel laureate Paul Krugman said in an Oct. 28 interview that the ECB should emulate the Fed and carry out quantitative easing.
For now, Europe’s central bank will stay on hold, said David Mackie, chief European economist at JPMorgan Chase & Co. in London. Policy makers believe the economy doesn’t need more aid and that providing it would fan inflation and ease pressure on governments to clean up their balance sheets, he said.
Bundesbank President Axel Weber is even campaigning for an immediate end to the ECB’s bond purchase-program, a push Trichet rejected. The ECB’s buying already differs from other quantitative-easing policies because the central bank mops up the resulting liquidity, meaning the net effect on the money supply is neutral.
The Bank of England is caught between the ECB and Fed. Its policy makers last month indicated they moved further toward raising their asset-purchase program from 200 billion pounds, according to the minutes of an Oct. 7 meeting at which they split three ways over what to do.
While inflation exceeded the government’s 3 percent limit for a seventh month in September and the economy unexpectedly grew 0.8 percent in the most-recent quarter, the second-fastest pace since 2007, the government is eliminating almost 500,000 public-sector jobs, and the housing market remains weak.
“There’s still a clear dovish leaning at the bank, and there are more headwinds coming,” said Ross Walker, an economist at Royal Bank of Scotland Group Plc in London. Thirty- eight out of 40 economists surveyed by Bloomberg News say policy makers won’t change their program this week.
The BOJ’s Shirakawa said Oct. 28 that shifting the date of his policy meeting to this week from Nov. 15-16 wasn’t linked to the Fed. Rather, policy makers want to discuss buying ETFs and REITs sooner than originally planned, having already agreed last week to purchase corporate debt with lower credit ratings than they had previously purchased, he said.
A weaker dollar would still risk undermining the world’s second largest economy, with the yen’s surge to a 15-year high already prompting companies such as Toyota Motor Corp. to cut back. Japanese government securities rose on speculation the BOJ could use the meeting to loosen credit further, with the 10-year bond capping seven straight months of gains last week.
The central bank will be “ready to take action after markets react to the Fed’s action,” said Takeshi Minami, chief economist at Norinchukin Research Institute Co. in Tokyo.
Emerging markets also already are feeling the “backwash” of low interest rates in the U.S. and elsewhere, said Rachel Lomax, a former Bank of England deputy governor. The Washington- based Institute of International Finance last month predicted net private-capital flows into emerging economies of $825 billion this year, the second strongest in history and most since 2007.
The glut of cash is prompting complaints and the use of capital controls and interventions. Brazilian Central Bank President Henrique Meirelles said Oct. 26 that an “expansionary monetary policy in some countries, particularly in the U.S.,” is creating challenges for economies such as his by leading to currency appreciation and potential asset bubbles.
In a nod to critics, finance chiefs from advanced nations agreed at a Group of 20 meeting on Oct. 23 to “be vigilant against excess volatility” in exchange rates.
“The emerging markets are very nervous,” Lomax, who is now on the board of HSBC Holdings Plc, said in an interview. “They have staged a magnificent expansion and need tighter policies now.”
Central banks outside the Group of Seven also meet this week. Economists surveyed by Bloomberg News are divided over whether the Reserve Bank of Australia will raise its 4.5 percent overnight cash rate and India’s central bank will increase its 6 percent repurchase rate. Also meeting this week are officials in Indonesia, Romania and the Czech Republic.
The differences in policies don’t necessarily signify the end of collaboration: In September, the Fed was among regulators from 27 countries who more than doubled capital requirements for banks; and in August, Bernanke, Trichet, Shirakawa and other central bankers gathered at the Fed’s annual Jackson Hole, Wyoming, conference to talk shop.
“It’s a more cooperative world than it was before the crisis,” said Steven Bell, chief economist at London-based hedge fund GLC Ltd. and a former U.K. Treasury official. “It’s just not as cooperative as it was when everyone was trying to stop the entire global financial system going down a plughole.”