ECB Joins Balance Sheet Expansion Parade

Monetary Policy Week in Review, 03-07 November 2014

by Peter Nielsen, Central Bank News

The fact that the 24 members of the European Central Bank’s (ECB) governing council – including Germany – agree that further unconventional measures should be deployed if necessary to boost inflation, was clearly the main news in global monetary policy last week.

Whatever differences were behind the ECB’s split decision in September to cut rates and purchase asset-backed securities along with covered bonds have now been set aside.

Although the ECB didn’t expand its stimulus measures last week, its president, Mario Draghi, went to great lengths to emphasize to that the ECB’s guidance and emphasis on expanding its balance sheet had been “signed by the whole Governing Council unanimously.”

In his prepared statement, Draghi reiterated the guidance from recent months that the council was unanimous in its commitment to using additional unconventional instruments if necessary to address the risk of too prolonged a period of low inflation.

But Draghi then went one major step further, saying the council had “tasked ECB staff and the relevant Eurosystem committees with ensuring the timely preparation of further measures to be implemented, if needed.”

The implication is clearly that the ECB is preparing markets for further stimulus in December when a likely downward revision in its latest economic forecasts provides it with solid reasons.

This mirrors the situation in September when the ECB cut its rate to essentially zero at 0.05 percent and embarked on quantitative easing (QE) by purchasing assets.

In September, ECB staff cut its 2014 growth forecast to 0.9 percent from 1.0 percent and the 2015 forecast to 1.6 percent from 1.7 percent. The forecast for inflation this year was revised downward to 0.6 percent from a June forecast of 0.7 percent while the 2015 forecast was maintained at 1.1 percent.

Since then, the European Commission has cut its 2014 growth forecast to 0.8 percent and the 2015 forecast to 1.1 percent. Euro area inflation in October was a mere 0.4 percent, well below the ECB’s objective of inflation that is just under 2 percent.

In addition to the reality of the worsening outlook, it seems the ECB council has taken a hard look at how the use of QE has been associated with accelerating growth and rising inflation in the United States and the United Kingdom.

While the balance sheets of the Federal Reserve and the Bank of England (BOE) have tripled or quadrupled in recent years, the ECB’s balance sheet has contracted.

The initial aim of the ECB’s current asset purchases is to reverse this trend and boost it by around 1 billion euros so it returns to the level in March 2012 when it was 2.96 trillion euros.

Next up for the ECB in December is likely to be a more ambitious target for expanding its balance sheet, either by purchasing sovereign bonds, supranational bonds or even corporate bonds, as the Bank of Japan (BOJ) has been doing.

“The lessons from other countries and other jurisdictions are very important in the sense that they make us think about how to make the most of the measures we may be taking,” Draghi said. Through the first 45 weeks of this year, the 90 central banks followed by Central Bank News have cut their policy rates 57 times, or 13.7 percent of this year’s 417 policy decisions, up from 13.5 percent at the end of the third quarter and 12 percent at the end of the first half, and 12 percent at the end of the first quarter. Meanwhile, rates have been raised 42 times, or 10.0 percent of all policy decisions, slightly down from 10.2 percent at the end of September, but up from 9.3 percent at the end of June and 8.7 percent at the end of March.

Boosted by Malawi’s 250 basis point rate rise, the Global Monetary Policy Rate – the average rate of the 90 central banks followed by Central Bank News – rose to 5.57 percent, up from 5.54 percent at the end of the third quarter and 5.53 percent at the end of the second quarter and first quarters.

LIST OF LAST WEEK’S CENTRAL BANK DECISIONS:

• Malawi raises rate 250 bps on rising food, falling kwacha
• Australia maintains rate and guidance of stable rates
• Eastern Caribbean holds rate, single fin sector urgent
• Romania cuts rate 25 bps on lower inflation outlook
• Kenya maintains rate, inflation seen moving toward target
• Thailand holds rate, stance “sufficiently accommodative”
• Iceland cuts rate 25 bps, wages to determine next move
• Poland holds rate as growth limits risk of low inflation
• Malaysia holds rate, drops warning of further rate rises
• Czech maintains rates, FX commitment, as expected
• ECB holds rates, prepares for further easing measures
• BOE maintains rates, stock of assets, as expected
• Bank of Mozambique lowers key interest rate (allAfrica)

LIST OF OTHER STORIES:

• FSB adds China AgBank as systemically important bank

TABLE WITH LAST WEEK’S MONETARY POLICY DECISIONS:

This week (Week 46) six central banks or monetary authorities are scheduled to decide on monetary policy: Armenia, Croatia, Serbia, Indonesia, South Korea and Peru. TABLE WITH THIS WEEK’S MONETARY POLICY DECISIONS:

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