June 24th, 2013
Monetary Policy Week in Review (Jun 17-21, 2013): 5 of 13 Central Banks Cut as Fed's Plan for QE Exit Roils Markets
by Peter Nielsen, Central Bank News
This week 13 central banks took policy decisions with the Federal Reserve’s narrowing of its timetable for normalizing monetary policy triggering higher U.S. interest rates and a plunge in global stock markets amidst concern over turmoil in China’s money markets.
At the press conference following this week’s meeting of the Federal Open Market Committee, Chairman Ben Bernanke firmed up his congressional comments from May 22, saying asset purchases would be slowly reduced later this year and then wound up by mid-2014, assuming the economy continues to expand.
It’s not immediately obvious why Bernanke’s statements caused such a ruckus in global financial markets as his reason for winding up years five years of ultra-easy monetary policy is basically good news: Falling unemployment and solid economic growth rather than a feared rise in inflation.
But the Federal Reserve’s decision to wave goodbye to quantitative easing may have come earlier than expected, surprising highly leveraged investors who relied on low interest rates to hunt for yields around the world. Like crack addicts that lose their mind when the dealer runs dry, they panicked.
U.S. long-term interest rates have shot up, global stock markets have plunged and capital has flowed out of emerging markets. Since early May benchmark U.S. 10 year yields have rocketed to over 2.5 percent from 1.66 percent, the highest in two years, tightening credit and mortgage conditions at the same time the Federal Reserve pumps in liquidity with monthly asset purchases of $85 billion and looks to keep short-term rates close to zero until late 2014 or early 2015.
The jump in U.S. interest was accompanied by a surge in Chinese money market rates, apparently because the Chinese central bank is attempting to let the air out of a credit bubble by reining in some forms of credit that have been used by the massive shadow banking sector.
While the Federal Reserve’s decision to wind up asset purchases was based on growing confidence about the economic outlook, Norway’s central bank turned more pessimistic though it was still among the eight central banks (India, Turkey, Egypt, Morocco, Namibia, Switzerland, Norway and the United States) that held rates steady this week.
Norges Bank signaled that it is likely to cut rates in the year ahead, dropping its tightening bias and completing a shift in policy that has been under way since October last year when it first started pushing back the timeframe for a rate rise.
Not only is Norway’s economy feeling the effects of the euro area’s recession, which it expects to persist for longer than expected, the central bank may be starting to worry about the specter of deflation, saying it is concerned that inflation expectations could become entrenched at too low a level.
Illustrating the growing role of central banks in financial stability, Norges Bank expects in September to issue rules on the size and timing of a countercyclical buffer that will be imposed on domestic banks to help dampen the continuing rise in household debt from a strong housing market.
The buffer – a concept introduced in the Basel III rules in 2010 – is aimed at boosting banks’ capital cushions so they can better weather a downturn when credit growth begins to pose a systemic risk.
The buffer adds to central banks’ growing arsenal of tools to fine-tune economic activity and will be useful to Norway’s central bank which fears that a rate cut will end up encouraging further debt and higher home prices.
Like Norway, Switzerland is also faced with strong real estate markets and plans to impose its own countercyclical buffer in September.
The Swiss National Bank (SNB) reiterated its determination to keep the franc from rising above 1.20 euros, saying the threat of upward pressure has not been averted as the franc remains sought after by investors seeking a safe haven.
The Reserve Bank of India (RBI), whose rupee has been falling in recent weeks along with other emerging market currencies, also held rates steady but warned of the inflationary impact of the falling exchange rate.
India is vulnerable to capital outflows due to its high current account deficit and the RBI was been reported to have intervened last week to support the rupee.
While most emerging markets are feeling the pressure from the outflow of capital, which is hitting their currencies, stock and bond markets, Pakistan has chosen a different route.
In contrast to Indonesia, which last week raised its rate to fend off inflationary pressure from a depreciating rupiah, Pakistan cut its policy rate this week in a calculated bet that a persistent outflow of capital would reverse due to improved sentiment among investors following the recent elections.
The State Bank of Pakistan (SBP), which has been worried over the impact on foreign exchange reserves from the lack of capital inflow, is also relying on inflation remaining under control – in May it hit the lowest level since October 2009 – to help attract capital and boost the growth of credit and thus economic activity.
Pakistan’s rupee has dropped by 1.7 percent against the U.S. dollar so far this year compared with Indonesia’s rupiah that has dropped almost 3.0 percent.
Through the first 25 weeks of this year, central bank policy rates have been cut 62 times, or 25.5 percent of the 243 policy decisions taken by the 90 central banks followed by Central Bank News. This is up from 24.8 percent after 23 weeks.
The number of rate increases this year was stable at 12, accounting for 5 percent of all policy decisions.
NEXT WEEK (week 26) features nine scheduled central bank policy meetings, including Israel, Armenia, Hungary, Taiwan, the Czech Republic, Fiji, Uruguay, Angola and Trinidad and Tobago.
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