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More Central Bank Cuts

May 5th, 2013
in econ_news

Monetary Policy Week In Review – May 4, 2013: Europe, India Cut Rates, Fed Assures QE Depends On Economy

by Peter Nielsen, Central Bank News

Last week 11 central banks took policy decisions with six banks keeping rates steady (Angola, Albania, the United States, the Czech Republic, Romania and Uganda), Bulgaria raising its rate and four banks cutting rates, most notably the European Central Bank (ECB) and the Reserve Bank of India (RBI) along with Denmark and Botswana.

Both the ECB and the RBI cut their key rates by 25 basis points, both rate cuts were widely expected and both central banks appealed – almost in unison – to their respective governments to get busy on reforming their economies as the problems, as ECB President Mario Draghi said,

cannot be fixed by monetary policy.

Follow up:

That sentiment was echoed by the RBI, which said

recent monetary policy action, by itself, cannot revive growth.

But that is where the similarities end.

While Draghi included pushing the deposit rate into negative territory in his adage, he also said the ECB is,

ready to act if needed,

the RBI, due to inflationary pressures, cautioned there was -

little space for further monetary easing”.

Despite his willingness to act, Draghi is running out of options to reverse Europe’s shrinking economy. Large banks can draw all the money they need from the ECB at a refinancing rate of 0.50 percent while banks that rely on the interbank market for funds pay 6-7 basis points, or “almost zero, ” as Draghi said.

And a plan to funnel loans to small and medium-sized businesses, mentioned by Draghi last month, turns out to be a very complex undertaking that will not happen in the near term.

Draghi said,

The ECB cannot clean bank’s balance sheets,

In the 17-nation euro area, he admitted that he was frustrated that his efforts were not ending up with -

better welfare, lower unemployment and better economic activity.

The core of the problem is that 80 percent of all loans or credits to businesses in Europe go through the banking system but banks are getting weaker and less able to lend as the ongoing recession increases the share on non-performing loans and toxic assets on their books. Some banks will now have to strengthen their capital base.

Draghi, adding that 80 percent of all financial intermediation in the U.S. goes via capital markets, said -

In Europe, you have to go through banks. You don’t have capital markets of the kind you have in the United States, so that we have to proceed via the banking system.

So together with the European Investment Bank (EIB), the ECB is working on ways to package and thus create a market for such loans, known as asset-backed securities (ABSs).

But it’s far from an easy task and the outcome is far from clear.

Draghi admitted,

We do not have a precise position on what we will do. You have to consider that the ABS market is dead and has been dead for a long time.

Another important event in central banking this week was the Federal Reserve’s  statement that it may either increase or decrease the amount of assets it will be purchasing, depending on the state of the U.S. jobs market and inflation.

Like the Bank of Japan and the Bank of England, the Federal Reserve has been engaged in purchasing various assets, mainly government bonds, to keep long-term interest rates low as a way to  stimulate economic activity when official policy rates hit the zero bound.

While the Federal Reserve is still sticking to its current plan of buying $85 billion worth of Treasuries and housing-related debt a month, the issue of how and when it will start to curtail these purchases weigh heavily on investors’ minds.

Although the Federal Reserve has assured markets that its “exceptionally” low target for the federal funds rate will remain in place for quite a while, any sign that it will reduce its asset purchases seems likely to be interpreted as the start of monetary tightening, sending shockwaves through financial markets.

Every word uttered by members of the Federal Open Market Committee of how and when the Federal Reserve will start to normalize monetary policy is causing jitters in markets, and the debate is likely to dominate sentiment for months.

Signs of an improving U.S. economy is immediately met by expectations that the Federal Reserve will wind down asset purchases while signs of a worsening economy is seen as a reason for expanding asset purchases.

By now officially linking its asset purchases to inflation and the jobs market – just like the federal funds rate – the Federal Reserve is seeking to soothe investors’ frayed nerves: Don’t worry, monetary policy will first be tightened when the economy is strong enough to handle it.

Through the first 18 weeks of this year, 20 percent of the 168 policy decisions taken by the 90 central banks followed by Central Bank News have lead to rate cuts, up from 19 percent after the first 17 weeks.

Central banks in emerging markets account for 38 percent of this year’s rate cuts, but thanks to this week’s cut by the ECB and Denmark, the ratio of rate cuts by banks in developed markets tripled to 9 percent from 3 percent.

Central banks from other markets – such as Botswana this week and Mongolia and Georgia in past weeks – account for 41 percent of all rate cuts this year.

But the overwhelming majority of this year’s decisions by central banks, 76 percent, have gone in favour of holding rates on hold following last year’s spree of rate cuts and the slow, but gradual improvement of the global economy.

Click to enlarge

Next week (week 19) features 13 central bank policy decisions, including Australia, Sri Lanka, New Zealand, Norway, Poland, Georgia, South Korea, United Kingdom, Malaysia, Peru, Egypt, the Philippines and Mozambique.

In addition, the U.K is hosting the spring meeting of Group of Seven (G7) finance ministers and central bank governors on Friday and Saturday. The G7, which has met regularly since 1976, comprises Canada, France, Germany, Italy, Japan, the UK and the USA. Representatives of the European Union, the ECB and heads of international financial institutions also attend the meetings.

Click to enlarge









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