Last week, the European Central Bank (ECB) and the People's Bank of China (PBC) both gave financial markets something to cheer about. This week the Federal Reserve and the Bank of Japan hold their monthly meetings. The latter could announce a further expansion of its already significant QE programme. No one expects the Fed to copy its peers. Indeed the expectation among the majority of economists polled in surveys is that the Fed is still poised to go in the opposite direction by raising interest rates at its December meeting. But we have been here as recently as last month when the Federal Reserve’s policy committee backed away from the rise in interest rates it had previously touted as coming.
Last week, Mario Draghi of the ECB forewarned that the central bank would act soon to forestall rising economic risks and stubborn, below target inflation. Until now, many analysts had been cautiously hopeful about the eurozone recovery which is steady, if slow, with loans to small companies and for house purchase picking up. But like its US counterpart last month, the ECB is anxious that the recovery could be shaken or knocked off course by the deteriorating situation in emerging markets, to which the eurozone sends about a quarter of the exports it ships outside the single currency area. German exports to China, for example, have faltered this summer.
Draghi said that "The degree of monetary policy accommodation will need to be re-examined at our December meeting." This is not a guarantee of new measures, but most people expect the ECB to announce larger and or more diverse asset purchases—it has been buying €60bn of sovereign bonds each month since March with a view to buying just over 1 trillion by September 2016. It could also entail an extension of purchases beyond September. The ECB could even cut its deposit rate now set at -0.2 per cent even further.
The ECB quickly ceded the limelight to the PBC, which announced its sixth round of reductions in both interest rates and bank reserve requirements reductions since the end of 2014. The benchmark lending and deposit rates were lowered to 4.35 per cent and 1.5 per cent, respectively. In what was more liberalisation than stimulus, the PBC also scrapped the remaining ceiling on bank deposit rates.
These measures don’t sit comfortably with recent economic statistics suggesting the economy was still growing at 6.9 per cent in the July-September quarter, in line with the official target of "about 7 per cent." The growth figures were not compatible either with bottom-up estimates of GDP growth in China's provinces, or with other recently reported data for fixed asset investment, housing and industrial production for the same period. They certainly didn’t reflect the drag from the finance sector in the wake of the equity market meltdown. If the economy really were expanding at a steady 7 per cent rate, there would be little reason for the serial easing in monetary policy. And if it isn’t, then even if these measures help to ease the burden on borrowers and on banks from rising non-performing loans, they are of little relevance to the task of stabilising China’s economic downturn and building new sources of growth.
Turning to the Federal Reserve, another policy meeting takes place this week but few expect it to focus on interest rates, which should be centre-stage at the Fed’s December meeting. The central bank’s prior concerns about the slowdown in China and emerging markets won’t have dissipated by then, but this week’s release of Q3 GDP should at least focus minds on how the US economy is doing. The headline numbers will be a lot lower than the 3.9 per cent in the second quarter, but the main reasons—the effect of a strong US dollar on trade and the build up in factory inventories should be temporary. This means that domestic demand in the US is still probably growing at a satisfactory rate.
The problem for the Fed is that if its peers are cutting rates or easing policy further, the US dollar is going to continue its assured ascent and this could again limit the Fed’s room to raise interest rates in December or after, even though it might have other cause so to do. The same goes for the UK, where Q3 GDP figures are released this week. Like the US, they are likely to be softer than in the spring quarter, but still show decent domestic demand growth. But strong sterling might also weigh on the MPC this winter.
So, easy money globally is making life difficult for the US and the UK. But no central banks are finding it easy to have a material impact on the domestic conditions they’d ideally want to try and influence. Of the 36 rich countries that comprise the OECD, 15 have raised interest rates since 2011 only to reverse the increase(s) subsequently, and in some cases, take interest rates down to lower levels than where they began. Some central banks, such as those of Switzerland, Sweden, Denmark and Norway have already gone into uncharted monetary waters. They have introduced and increased negative interest rates, so that commercial banks actually pay to keep balances at the central bank. The ECB has also introduced a negative deposit rate. But to what effect?
There is no question that unusual and easy central bank policies have proven to be an elixir for equity markets. The major bear market in global equities we were told by many to expect following the slump in Chinese equity markets and the cackhanded mini-devaluation of the Yuan, didn’t happen, as you have probably noticed.
The US equity market has bounced back, and is up for the year to date. The FTSE 100 index has risen from below 6,000 to about 6,400, or roughly half way back to its peak for the year. A widely followed index of emerging market equities, which fell by a third from the middle of 2014 to the summer of 2015, has risen by over 10 per cent in October so far. Thanks be to cheap money.
And yet with the passage of time and every new set of measures, the effectiveness of monetary policy on the economy, and therefore, on global growth seems to diminish. We have a growth crisis going on in emerging markets that has already felled Russia and Brazil, and that is still working its way through China, a swathe of commodity exporting countries such as Chile and, to a lesser extent, manufacturing exporting countries such as Turkey. Awkward political issues in many countries are colluding with the growth crisis to create economic and financial circumstances that show few signs of ending soon.
In developed economies, domestic demand conditions have been firming—more so in the US and UK than in the eurozone and Japan. But inflation has nevertheless remained around zero or negative, or excluding the falls in food and energy prices, around 1 per cent. These are circumstances in which central banks are only comfortable with the status quo or easing policy further. With governments having abdicated responsibilities for steering the macro economy, we are left only with easy money that inflates asset prices but doesn’t gain real traction in the economy.
We don’t know how this story ends. Except that isn’t as simple as it’s been made to look. Either the case for more easing is going to be negated, starting in the US and the UK, as reported inflation rises this winter and domestic demand stays firm, or central banks will introduce new, or higher inflation, targets in a further attempt to be relevant.
