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Central banks drop tightening talk as easy money goes on

Section: Daily Dispatches

By Simon Kennedy and Jeff Kearns
Bloomberg News
Friday, October 25, 2013

The era of easy money is shaping up to keep going into 2014.

The Bank of Canada's dropping of language about the need for future interest-rate increases and today's decisions by central banks in Norway, Sweden, and the Philippines to leave their rates on hold unite them with counterparts in reinforcing rather than retracting loose monetary policy. The Federal Reserve delayed a pullback in asset purchases, while emerging markets from Hungary to Chile cut borrowing costs in the past two months.

"We are at the cusp of another round of global monetary easing," said Joachim Fels, co-chief global economist at Morgan Stanley in London.

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Policy makers are reacting to another cooling of global growth, led this time by weakening in developing nations while inflation and job growth remain stagnant in much of the industrial world. The risk is that continued stimulus will inflate asset bubbles central bankers will have to deal with later. Already talk of unsustainable home-price increases is spreading from Germany to New Zealand, while the MSCI World Index of developed-world stock markets is near its highest level since 2007.

"We are undoubtedly seeing these central bankers go wild," said Richard Gilhooly, an interest-rate strategist at TD Securities Inc. in New York. They "are just pumping liquidity hand over fist and promising to keep rates down. It's not normal."

Normal or not, that's been the environment now for five years after monetary authorities fought to protect the world economy from deflation and to hasten its recovery. In the advanced world, central banks drove interest rates close to zero and ballooned their balance sheets beyond $20 trillion through repeated rounds of bond purchases, a policy known as quantitative easing.

The economic payoff has been limited. The International Monetary Fund this month lopped its forecast for global economic growth to 2.9 percent in 2013 and 3.6 percent in 2014, from July's projected rates of 3.1 percent this year and 3.8 percent next year. It also sees inflation across rich countries already short of the 2 percent rate favored by most central banks.

Central bankers are on guard to keep low inflation from turning into deflation, a broad-based decline in prices that leads households to hold off purchases and companies to postpone investment and hiring.

"There is a concern at central banks that what we're seeing is another false start in their economies," said Michala Marcussen, global head of economics at Societe Generale SA in London. "We now need to see two to three months of better numbers before they're willing to contemplate an exit again."

After flirting for months with the idea of curtailing stimulus, the Fed said in September it would continue purchasing $85 billion of bonds a month, citing the need to see more evidence that the U.S. economy will improve.

That came less than two weeks before a 16-day U.S. government shutdown that postponed releases of key data the Fed is relying on to guide its policy decisions. The Fed's strategy also took a hit from this week's news that employers added fewer workers to payrolls than projected in September.

The Fed will wait until March before slowing the pace of its third round of quantitative easing, according to the median estimate of economists in an Oct. 17-18 Bloomberg survey.

"If you look at where we are economically versus where we were a year ago, we're virtually in the exact same place," Gary D. Cohn, president of Goldman Sachs Group Inc., said yesterday in a Bloomberg Television interview with Stephanie Ruhle. "So if quantitative easing made sense a year ago, it probably still makes sense today."

That leaves central banks elsewhere likely to maintain a bias toward easing. Moving to tighten before the Fed is ready to do so would drive up currencies against the dollar, to the detriment of exports, said Derek Holt, vice president of economics at Bank of Nova Scotia in Toronto.

The Bank of Canada, citing "uncertain global and domestic economic conditions," yesterday omitted language it used in previous decisions referring to the expected "gradual normalization" of its benchmark rate, now at 1 percent.

The Riksbank kept its rate at 1 percent today and said it sees it at 1.15 percent in the fourth quarter next year, versus 1.25 percent in September. "The repo rate needs to remain at this low level until economic activity is stronger and inflation rises," it said. Norway left its benchmark rate at 1.5 percent today, a month after signaling it will move toward tighter policy as house prices and consumer debt hover at record levels.

The Philippines also held its rate at a record low 3.5 percent to support Southeast Asia's fastest growing economy as inflation stays within the central bank's targeted range.

"There's an easy-money bias across global central banks that probably will persist until about March or April," said Holt. "The Fed's decisions complicated the exit strategies for a lot of central banks."

If the Fed's delay extends the decline in the dollar, then the Bank of Japan and the European Central Bank also are more likely to add fresh stimulus, Fels said in an Oct. 20 report. The ECB is likely to offer banks another round of cheap, long-term loans in the first quarter, while the BOJ may ease more to offset a 2014 consumption tax increase, Citigroup Inc. economists said in a report yesterday.

The dollar has declined 1.1 percent against a basket of 10 leading global currencies in the last month, according to the Bloomberg U.S. dollar index.

Some central banks in emerging markets are already acting. Chile unexpectedly lowered its benchmark rate by a quarter point to 4.75 percent on Oct. 17, pointing to weaker growth, inflation and the global outlook. Israel surprised analysts on Sept. 23 when it cut its key rate a quarter point to 1 percent, the lowest in almost four years.

"With the dollar much weaker in recent days and weeks, you'll see central banks that were reluctant to ease start to do that now," said Thierry Wizman, global interest rates and currencies strategist at Macquarie Group Ltd. in New York. "They can be less worried about capital flight if the Fed isn't tightening policy, and the strength in their currencies is probably imparting some disinflation into their economies, giving them a window to cut rates."

Hungary, Latvia, Romania, Serbia, Sri Lanka, Egypt, and Mexico have also eased since the start of September although Indonesia, Pakistan, Uganda, and India tightened, with the latter softening the blow by relaxing liquidity curbs in the banking system at the same time. Chinese policy makers have also been draining cash from the financial system.

Even those central banks with limited room to act are using so-called forward guidance to deter investors from betting on an imminent increase in rates. The ECB vows to keep its main rate at 0.5 percent for an "extended period" and the Bank of England is pledging to maintain its benchmark at the same level at least until unemployment falls to 7 percent, which it doesn't expect to happen for three years.

The Bank of Japan is trying to expand its monetary base by 60 trillion to 70 trillion yen ($720 billion) to bring inflation up to 2 percent.

The Fed also depends on forward guidance as a policy tool. Officials have repeated in every policy statement since December that their target interest rate will remain near zero "at least as long as" unemployment exceeds 6.5 percent, so long as the outlook for inflation is no higher than 2.5 percent.

"It’s hard to look around and see much changing on the rate front," said David Hensley, director of global economic coordination at JPMorgan Chase & Co. in New York, who forecasts the average interest rate in developed economies to hold close to the current 0.40 percent for another year.

The cheap cash may come at a price that policy makers will have to pay later if it inflates asset bubbles. Germany's Bundesbank said this week that apartments in the country's largest cities may be overvalued by as much as 20 percent. In the U.K., Band of England officials are rebutting suggestions of a housing bubble. Asking prices in London jumped 10.2 percent in October from the prior month, Rightmove Plc said Oct. 21.

Bank of England Governor Mark Carney today unveiled a revamp of the central bank's money-market operations to widen access and cut the cost of liquidity insurance to the financial system. The BOE will expand the range of collateral it accepts in its facilities and offer money for longer periods on cheaper terms, Carney said in a speech in London.

Swedish and Norwegian property markets are also proving a concern to their central bankers, and policy makers in New Zealand and Singapore have already sought to cool demand. Meantime, U.S. stocks are heading toward the best year in a decade with about $4 trillion added to U.S. share values this year.

"The bubble conditions are going to remain in place," Michael Ingram, a market strategist at BGC Partners LP in London, told Bloomberg Radio's Bob Moon yesterday. "We could well see further stimulus."

For now, such concerns are being overridden by a need to enhance economic expansion. The U.S. unemployment rate, at 7.2 percent in September, is still only the lowest since November 2008 and joblessness is 12 percent in the 17-nation euro area.

"Whatever their official mandates, central bankers are supposed to safeguard a nation's real income," Karen Ward, senior global economist at HSBC Holdings Plc in London, said in an Oct. 21 report. Labor markets from the U.S. to U.K. suggest "we shouldn't fear a rapid withdrawal of global liquidity any time soon.'

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