Monetary Policy Week in Review 16-20 December 2013

Financial markets welcome Fed’s change of direction

by Peter Nielsen, Central Bank News

Financial markets declared ‘mission accomplished’ this week as the Federal Reserve finally changed the direction of U.S. monetary policy and started to wind down five years of extraordinary accommodation.

Within hours of its decision, any uncertainty in financial markets over the near-term direction of the U.S economy and monetary policy had evaporated as the Fed succeeding in convincing skeptics that “QE Infinity” is a figment of their imagination and the economy is now strong enough to weather a slow but steady return to normality.

By combining a “modest” $10 billion reduction in monthly asset purchases to $75 billion with a likely extension of zero percent interest rates beyond expectations, the Fed drilled home its message that a tapering of quantitative easing does not equal a tightening of monetary policy.

Most importantly, the Fed has changed the global narrative of ultra-easy monetary policy and plotted a course for other major central banks to follow as their time comes to shrink balance sheets.

A collective cheer echoed through financial markets and the halls of central banks worldwide as it slowly dawned upon them that the global economy is truly healing and moving beyond the ravages of the worst crises since the Great Depression.

The central banks of Japan, China and Taiwan welcomed the Fed’s move as a sign the U.S. economy, and by extension the global economy, is recovering while Hong Kong’s monetary authority focused on the reduced risk of asset bubbles and Brazil’s finance minister saw a likely reduction in foreign exchange market volatility.

But amidst the hoopla surrounding the Fed’s decision, it is clear that inflation is too low for comfort in most economies.

Last week all four central banks that cut their rates – Sweden, Serbia, Hungary and Albania – acted in response to lower-than-expected inflation while the Fed said inflation persistently below its target could pose a risk to the economy and the Czech Republic’s central bank is using foreign exchange intervention to eliminate the threat of deflation.

At the same time, economic growth appears to be finding its footing, with the central banks of Sweden, Hungary and Japan seeing stronger growth and Colombia going so far as to say the global economy was now better than expected.

Through the first 51 weeks of this year, central banks have cut their policy rates 116 times, or 23.25 percent of the 499 policy decisions taken by the 90 central banks followed by Central Bank News, up from 23.0 percent the previous week but down from 25.3 percent after the first half of the year.

Policy rates have been raised 26 times this year, or 5.2 percent of this year’s policy decisions, down from 5.5 percent the previous week but up from 4.7 percent after the first half of the year.

LIST OF LAST WEEK’S (WEEK 51) STORIES:

• Sweden cuts rate 25 bps, pushes back rate rise until 2015
• Serbia cuts rate 50 bps, policy aims at boosting inflation
• Hungary cuts 20 bps to 3.0%, more easing may follow
• Turkey holds rate, may revise policy on new information
• Morocco holds rate, revises up 2014 inflation forecast
• Czech central bank confirms FX target, holds rates
• Albania cuts rates a further 25 bsp to 3.0%
• India holds rates but ready to act if inflation doesn’t’ fall
• US Fed to taper asset purchases by $10 bln from January
• Georgia holds rate as inflation seen moving to target
• Japan maintains stance, now sees recovery “as a trend“
• Colombia holds rate, world economy better than expected

TABLE WITH LAST WEEK’S MONETARY POLICY DECISIONS:

This week (week 52 and the final week of the year) four central banks are scheduled to hold policy meetings, including Angola, Israel, Armenia and Taiwan.