Global central banks have pivoted towards accommodation this year, faced by the vagaries of US-Sino trade wars impacting the manufacturing sector in most economies. This article details expectations from the ensuing meetings of the major central banks this month and concludes with the need for a debate on the effectiveness of unconventional monetary policies.
The key event this month is the rate decision by the apex global central bank – the Federal Reserve on September 18, 2019. While the Fed Chair had insinuated the July rate cut decision as a ‘mid-cycle adjustment’, events that unfolded post the decision have led to a change in rhetoric. Escalation of US-China trade conflicts in early August, led to the Yuan breach the psychological 7.00 mark, prompting the US to label the Asian country as a currency manipulator. Since then, uncertainties on the trade front have been rife, impacting business sentiment in turn threatening global growth. This has led to a shift in sentiment in the Fed, with public communication signalling the need to “act as appropriate to maintain expansion”, which makes us believe that the Fed would cut rates by 25 bps in its upcoming policy.
The other key central bank event that will be closely watched by the markets is the ECB Governing Council Meeting on September 12, 2019. Markets are expecting a change in guidance, with extension in the minimum period for unchanged or lower interest rate to move beyond the current March 2020 and a change towards a symmetrical inflation target. Secondly lowering of deposit rates by 10 bps and a higher second tiered rate which could be used by banks to deposit money with the ECB up to a certain level, is widely expected. Lastly there are expectations of a quantitative easing programme to be introduced.
These expectations of monetary policy easing are at the back of flagging growth in the Eurozone, mired by global trade conflicts and Brexit uncertainties. While the current slowdown in growth impulses is largely seen in the manufacturing sector, labour markets continue to be tight reflected in robust consumer spending. This is also manifesting in the dichotomous growth across the region with trade dependent economies – Germany and Italy – seeing weak growth while the more domestic, consumption-based economies -- Spain and France -- seeing better growth numbers.
Bank of Japan (BoJ) has also signalled pre-emptive easing through a combination of one or more tools available at its disposal, including cutting rates further into negative territory, if trade concerns threaten growth outlook further. A pivotal concern for the BoJ is the flattening in the sovereign yield curve that goes against the objectives that were laid out as part of its yield curve control (YCC) programme. A possible lowering of 10-year yields could pose a substantial headwind to the banking sector, and could lead the BoJ to make changes to its monetary policy framework.
On the other hand, Bank of England (BoE) has consistently resisted joining the global tide of central banks shift towards accommodation, though the rhetoric towards hawkishness seems to be ebbing. This could be on account of increased threats of global slowdown along with continued uncertainties on the Brexit front. We think that the BoE will maintain status quo until the ‘Brexit’ outcome is known, with a ‘Hard-Brexit’ prompting the BoE towards easing.
Given this recent push on the pedal by most global central banks towards accommodation, with possibility of increased use of the so-called ‘unconventional monetary policies’ which gained prominence post the global financial crisis, it is important to introduce the debate on the effectiveness of these policies. There is growing evidence that these policies are losing their efficacy over time with a given central bank balance sheet change having a smaller impact on sovereign yields. Moreover, despite easing monetary policy, inflation rates in most of the advanced world has remained muted, leading central banks to speculate that ‘natural rates’ have been falling, which in turn leads the private sector to believe so as well. These actions have led monetary policy to be less simulative than expected, through a self-fulfilling mechanism, the subject matter of which can be the fodder for an entire article on its own. The current global growth slowdown, could warrant a push from fiscal policy rather than just monetary policy being the proverbial ‘Atlas’ – shouldering global growth on its shoulders.
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B Prasanna is head of global markets at ICICI Bank. here.