Central Bank Poker: Six Holds, 2 Cuts and a Raise

Monetary Policy Week in Review – Mar 23, 2013: Two Banks Cut, Six Hold, Egypt Raises, BOE Remit Expands

by Peter Nielsen, Central Bank News

Last week nine central banks took policy decisions with six keeping rates on hold while Colombia and India again cut rates, and Egypt became the first emerging market central bank to raise rates this year in an attempt to stem inflationary pressures despite the fragile economic environment.

But the latest developments in monetary policy – even the Bank of England’s expanded remit and a U.S. Federal Reserve meeting – were overshadowed by the latest installment in the running euro zone drama, an event with the potential to reignite last year’s crises and “undermine growth prospects further,” as the South African Reserve Bank observed.

Much was written about the awful decision to impose a tax on Cyprus’ small bank depositors. Philip Lowe, deputy governor of the Reserve Bank of Australia, summed up much of the criticism, saying the decision threatens the integrity of all euro zone bank deposits and could lead to a run on banks in other countries – hardly the way to create a stable banking system and boost confidence.

Through the first 12 weeks of the year, 78 percent of the 112 policy decisions taken by the 90 central banks followed by Central Bank News lead to unchanged rates, the same percentage as after the first 11 weeks.

The six central banks that held rates steady last week included those from Nigeria, the United States, South Africa, Iceland, Trinidad & Tobago and Uruguay.

Globally, 19 percent of policy decisions so far this year have lead to rate cuts, largely by central banks in emerging economies, a ratio that was steady from last week.

Half of this year’s 21 rate cuts worldwide have come from emerging market central banks and last week India and Colombia continued to ease their policy stances, as widely expected.

But while the Reserve Bank of India said it has limited room to cut rates further given inflationary pressures, Banco de la Republica Colombia complained that its rate cuts have not been transmitted fast enough to the economy and inflation is forecast to remain below target.

Egypt became the first emerging market central bank to raise rates this year, a decision that must have pained its policy makers given the battering its economy has taken during two years of political turmoil following the overthrow of President Hosni Mubarak.

But the Central Bank of Egypt judged that “disanchored inflation expectations are more detrimental to the economy in the medium term,” and raised rates by 50 basis points. It warned that it would not hesitate to change rates again to ensure price stability.

The Federal Reserve’s Federal Open Market Committee decided to continue with its monthly purchases of $85 billion of housing-market debt and Treasuries, a decision that was widely expected.

The Bank of England (BOE) was in the news last week with the UK Chancellor of the Exchequer, or finance minister, adjusting its remit, giving it more flexibility to tackle the sluggish economy.

The Chancellor, George Osborne, confirmed the 2 percent inflation target and re-stated the primacy of price stability in the monetary policy framework instead of picking a nominal growth target as had been discussed in media.

He confirmed that the BOE should be flexible in its interpretation of this medium-term inflation target. This means that as long as inflation is trending toward 2 percent, the BOE can use “monetary activism” and deploy new unconventional policy instruments – in consultation with the government – that other central banks have used to help stimulate growth.

But the BOE’s remit was adjusted in two important ways.

Firstly, the BOE can now “deploy explicit forward guidance,” a phrase that describes how central banks manage expectations by informing investors of the expected future path of policy rates.

As long as the central bank is credible, the thinking is that financial markets will then align market rates, especially long-term rates, to reflect the central bank’s guidance and thus support its policy.

Secondly, this forward guidance – used by a growing number of central banks worldwide – will now be linked to specific thresholds of the BOE’s own choosing. This is similar to the Federal Reserve which started in December telling markets that it expects to maintain ultra-low rates at least as long as the unemployment rate is above 6.5 percent and inflation doesn’t top 2.5 percent.

The BOE will give an assessment of the use of thresholds and which it may employ in its August inflation report, the month after Bank of Canada Governor Mark Carney takes over from Mervyn King. Under Carney, the Bank of Canada was the first central bank to start using forward rate guidance in April 2009.

There was good news from global banking regulators.

In its latest survey of how major banks would do under the new Basel III regulations, the Basel Committee on Banking Supervisors found that the largest global banks now only have a capital shortfall of 3.7 billion euros, down by 8.2 billion in the first half of 2012.

One of the factors restraining banks from lending and thus stimulating economic activity has been the need to shore up their capital base in light of new tougher banking regulations.  Once the banks meet those regulations, they should become more eager to extend loans.

Illustrating the subdued state of global banking, the latest quarterly review from the Bank for International Settlements (BIS) said total cross-border lending by major banks rose by only 0.1 percent, or $33 billion, in the third quarter of 2012, the smallest quarterly rise registered by the BIS in 13 years.

But while lending to the euro zone continued to contract, the BIS highlighted the growth of Asian capital markets. Central bankers have worked for many years to deepen Asia’s markets.

BIS data showed that global bank lending to Asia-Pacific is contracting while private, non-banks, especially high net worth retail investors, are plowing funds into that region as corporate bond markets develop.

The inflow of capital to emerging economies from banks dropped to $147 billion in 2012 from $154 billion in 2009, while the inflow of private funds to those economies has exploded to $365 billion from $155 billion.

LAST WEEK’S (WEEK 12) MONETARY POLICY DECISIONS:

Next week (week 13) features 11 central bank policy decisions, including Israel, Angola, Turkey, Morocco, Hungary, Georgia, Taiwan, Zambia, the Czech Republic, Fiji and Romania.