Monetary Policy Week in Review Jan 20-24, 2014

Hungary and Jordan cut rates as volatility returns in 2014

by Peter Nielsen, Central Bank News

Last week in global monetary policy the central banks of Jordan and Hungary cut their policy rates, while Turkey’s central bank carried out another of its stealth tightening operations as financial markets encountered their first bout of volatility in 2014.

A surprising contraction in China’s manufacturing sector triggered a sell-off in stock markets and a fall in the currencies of most emerging markets as financial markets continued the adjustment started last summer to a world of reduced stimulus from the U.S. Federal Reserve and improving growth in advanced economies.

So far this year the global trend toward lower official interest rates is continuing as five central banks – Uzbekistan, Romania, Tajikistan, Jordan and Hungary – have cut rates through the first four weeks of 2014 to shore up still sluggish economic growth, compared with the one rate rise by Brazil.

While global growth prospects are improving, central banks are clearly alert to the possibility that financial markets can turn jittery and thus limit national policy options.

Last week Hungary’s central bank acknowledged that a “cautious approach to policy is warranted due to uncertainty related to the global financial environment,” while Nigeria’s central bank said a “reduction of the US stimulus especially, could in addition, trigger capital flow reversals and put greater pressure on the naira exchange rate.”

On Friday Reuters reported that the central banks of India, Taiwan and Malaysia were believed to have intervened to defend their currencies while Russia continued its recent policy of moving the rouble’s trading band after $350 million in hard currency sales.

Paradoxically, news that the European Central Bank (ECB), the Bank of England (BOE), the Bank of Japan (BOJ) and the Swiss National Bank (SNB) had decided to cease three-month U.S. dollar liquidity operations due to low demand, was seen as contributing to the view that central banks in advanced economies were turning less dovish and thus making investments in emerging markets even less attractive.

While the U.S. Fed already started reducing its asset purchases this month and is likely to announce another modest reduction this week, the spotlight is now squarely on the BOE and how it will respond to improving growth.

In August the BOE set out the threshold of a 7 percent unemployment rate for considering whether it would maintain its current policy stance or start to withdraw the extraordinary stimulus. It seems to have fallen on deaf ears that the BOE clearly said that no single indicator could summarize economic conditions and reaching a 7 percent jobless rate would not automatically lead to a rate rise.

But at that point, the BOE anticipated a 7 percent jobless rate in 2016 and news that it fell to 7.1 percent in November has triggered speculation that the BOE will raise rates in the near term or even scrap its forward guidance.

But there seems little justification for such views.

In his speech on Friday in the Swiss resort of Davos, BOE Governor Mark Carney once again clearly said the “attainment of the 7% threshold will not be associated with any immediate need to raise the Bank Rate” and the forward guidance would be updated to reflect the better outlook for inflation and what the bank had leant about the behavior of supply in the economy.