April 8th, 2014
by Peter Nielsen, Central Bank News
The central banks of Brazil and Ghana raised their policy rates last week as six other central banks left their rates unchanged, including the the European Central Bank (ECB), which nevertheless took a major step forward toward launching some form of unconventional monetary measure if inflation threatens to remain at the current low level.
Despite the two rate rises, the Global Monetary Policy Rate (GMPR) - the average policy rate of 90 central banks followed by Central Bank News - remained steady at 5.56 percent from the end of March, but was up from 5.55 percent at the end of February and 5.53 percent at the end of January, illustrating how monetary policy worldwide is slowly but surely tightening. Through the first 14 weeks of this year, policy rates have been raised 13 times, or 9.7 percent of this year's 134 policy decisions by the 90 central banks, up from 8.7 percent from the previous week.
But on a global scale, economic growth is still sluggish and inflation low, with the result that monetary policy is still being loosened in some countries. So far this year, policy rates have been cut 15 times, or 11 percent of this year's policy decisions, down from 12 percent at the end of the previous week and 14 percent at the end of February. The main events in global monetary policy last week were the policy decisions by the ECB and the Central Bank of Brazil.
The ECB once again dashed hopes for a rate cut or some type of unconventional policy measure, such as quantitative easing or a negative deposit rate, amid renewed concerns over deflation.
Nevertheless, the ECB took a major step forward in preparing financial markets and investors for the possibility of introducing some form of quantitative easing if inflation does not start to rise soon.
Inflation in the euro zone fell to 0.5 percent in March from 0.7 percent in February and has now remained under 2 percent for the last 14 months. The ECB targets inflation of close to, but below 2 percent.
But ECB President Mario Draghi dismissed concerns of Japanese-style deflation, telling a press conference that "frankly we do not see the risks of deflation as having increased."
Explaining that the March inflation figure was impacted by this year's timing of Easter along with the base effect of energy prices, Draghi said the ECB and financial markets are still expecting inflation to rise as the economy improves. At this point, deflation is not priced into markets.
However, the ECB council is clearly worried that the longer inflation remains at such a low level, it could lead to a fall in inflationary expectations. This would pave the way for consumers to postpone purchases and thus further delay the economic recovery.
"It is quite obvious that the Governing council is looking at this prolonged period of low inflation and it is quite obvious that the longer the period of low inflation, the higher the risk for inflation expectations in the medium and long term," Draghi told the press conference.
In an apparent reflection of the Bundesbank's recent acceptance of quantitative easing, Draghi said the ECB council was "unanimous in its commitment to using also unconventional measures," pointedly saying the ECB mandate would allow it to engage in quantitative easing.
In contrast to the council's meeting last month, the ECB this time specifically discussed various forms of quantitative easing during what Draghi described as "a very rich and ample discussion."
There are two reasons the ECB has been reluctant to undertake some form of quantitative easing, such as buying government or private sector bonds, as carried out by the Bank of Japan, the U.S. Federal Reserve and the Bank of England.
The first and primary reason is that euro zone firms, unlike U.S. companies, rely much more on bank lending than capital markets for funds. When the Fed, for example, purchases bonds, it quickly affects the cost of credit whereas the health of banks is more critical to euro zone business.
"In our case, the economy is based on the bank lending channel and therefore the programme has to be carefully designed in order to take this element into account," Draghi said, showing just how far along the ECB is in considering the details of its form of quantitative easing.
The second reason that the ECB has been reluctant to engage in quantitative easing by buying sovereign bonds is that it would be dealing with 18 national bond markets, making such an operation much more complex to design and execute. In Brazil, the central bank raised its rate for the ninth time since embarking on its tightening campaign in April last year but signaled that is now ready to take a breather to judge the impact on inflation from its 375 basis-point hike in the benchmark Selic rate.
As usual, the statement from the Central Bank of Brazil's policy committee, known as Copom, was slightly cryptic but the message was received by financial markets and the real currency fell.
In its statement, the central bank dropped earlier references to rate rises as a continuation of a process that got under way in April 2013 and inserted that the decision was taken "at this moment," conveying the impression that the latest rate rise was more of a one-off than part of a tightening cycle.
In addition, Copom also said its next move would be based on "the evolution of the macroeconomic scenario," signaling that the rate could be maintained in May unless inflation accelerates sharply.
Brazil's inflation rate rose in February to 5.68 percent from 5.59 percent, but this was partly due to higher food prices from the impact of severe drought in southern Brazil.
And although the central bank has already raised its 2014 inflation forecast to 6.1 percent from 5.6 percent as a result, inflation is still within the central bank's tolerance range of 2.5 to 6.5 percent and the economy is clearly in need of stimulation. LIST OF LAST WEEK'S CENTRAL BANK DECISIONS:
- Fiji holds rate on comfortable inflation, reserves outlook
- Australia holds rate, repeats steady rates for a period
- Angola holds rate, cuts standing, raises absorption rate
- Uganda holds rate, sees lower short-term inflation
- Ghana holds rate, raises CRR, cuts NOP limits
- India holds rate steady, further policy tightening not expected
- Brazil raises rate to 11%, next move depends on economy
- ECB ready to cut rate, other measures to boost inflation
TABLE WITH LAST WEEK'S MONETARY POLICY DECISIONS:
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This week (Week 15) eight central banks will be deciding on monetary policy, including Japan, Indonesia, Croatia, Sweden, Poland, United Kingdom, South Korea and Peru.
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