This week two major emerging market central banks raised rates while two minor banks cut rates as global financial markets continued to yo-yo in response to the U.S. Federal Reserve’s valiant attempts to be transparent over its plan to normalize monetary policy and exit quantitative easing.
It was always clear that the process of winding down asset purchases would be tricky, not only because financial markets have grown accustomed to the steady supply of free money but also because there is no road map for central banks to follow.
But to observe Federal Reserve Chairman Ben Bernanke’s heroic attempts to explain the difference between a “highly accommodative” policy stance (a reference to the exceptionally low federal funds rate) and “increased policy accommodation” (a reference to asset purchases) is bordering on the surreal.
While there are many benefits to investors and financial markets from central banks’ move toward more open communication, greater asset price volatility seems to be one of the drawbacks when policy makers are navigating unchartered waters and basing decisions on real-time economic data.
As a general rule, financial markets typically overreact to unexpected changes in central banks’ policy so the sharp rise in bond yields in May and June – probably an excessive rise - was entirely rational as Bernanke’s consistent message was that the days of ultra-easy U.S. monetary policy are on the wane.
But to ensure that the rise in bond yields doesn’t derail the economic recovery – a fear already voiced by the Bank of England and the European Central Bank – Bernanke then reminded markets that the “highly accommodative monetary policy” (i.e. short-term rates) will be needed for the foreseeable future, and the Fed would respond if financial conditions tighten too much – a clear reminder that the “Bernanke Put” is still alive and well.
The spillover from the change in U.S. monetary policy to emerging markets has been widespread since early May, triggering intervention in foreign exchange markets and contributing to at least one rate hike to dampen the outflow of capital and a sharp decline in currencies.
This week the central banks of South Korea, Mexico and Serbia – which all held their rates steady - referred to the tapering of U.S. asset purchases as a downside risk to growth due to the rise in local bond yields and currency depreciation.
But it was interesting that Mexico described the rise in bond yields and a decline in its currency as taking place in “orderly fashion” and this would not lead to inflationary pressures due to the slack in the economy.
By downplaying the impact of the fall in the peso in May and early June – the peso rebounded in late June - the Mexican central bank confirmed that the impact on emerging markets from an eventual tightening of U.S. monetary policy is unlikely to be as dramatic as in the 1980s and 1990s when financial crises followed.
The Bank of Thailand, which also held rates steady this week, looked at the other side of the coin of an expected tapering of U.S. asset purchases, noting improvements in the U.S. economy from better housing and labour market conditions.
Another central bank to look at the bright side was the Bank of Japan, which for the first time in two years used the word “recovery” to describe its economy. And while it is clear that the economy is strengthening, it is still early days and prices are still falling. The BOJ’s confidence may be growing, but it still adds the adjective of “moderate” to the describe the recovery.
But while the U.S. and Japanese economies appear to be strengthening, the slowdown in China has hit economies worldwide. The Bank of Korea, which also held rates steady, and Thailand specifically pointed to the negative impact of China while the central banks of Malaysia, Chile and Russia – which also maintained their rates - merely referred to the weak global environment.
The surprise of the week came from the Bank of Indonesia, which raised rates by 50 basis points – markets had expected a 25 point rise – signaling that it will go to great lengths to contain inflationary expectations and stop any second-round effects from the government’s long-awaited rise in fuel prices.
The Central Bank of Brazil also hiked rates by 50 basis points, a move that was largely expected, illustrating the same determination to avoid a further rise in inflation, an even more present danger due to the recent depreciation of Brazil’s real and Indonesia’s rupiah.
This week’s two rate cuts came from Latvia and Tajikistan, with both central banks taking advantage of low inflation to stimulate growth. Latvia, which cut its rate by 50 basis points to 2.0 percent, also needs to slowly narrow the gap to the European Central Bank’s 0.50 percent refinancing rate, before becoming the 18th nation to use the euro from January 1, 2014.
Through the first 28 weeks of this year, central bank policy rates have been cut 69 times, or 24.8 percent of the 274 policy decisions taken by the 90 central banks followed by Central Bank News, slightly down from 25.4 percent last week and 24.9 percent the previous week.
While the global trend remains firmly toward lower policy rates, the number of rate rises has been inching up ever so slowly. Policy rates have been raised 14 times this year, accounting for 5.1 percent of all decisions, up from 4.6 percent last week.
Last week 10 central banks maintained their rates, including the central banks of Thailand, Kenya, Japan, Korea, Serbia, Malaysia, Peru, Mexico, Russia and Chile.
LAST WEEK’S (WEEK 28) MONETARY POLICY DECISIONS:
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Next week (week 29) is quiet on the monetary policy front, with only two banks scheduled to hold policy meetings: Canada and South Africa. On Friday the 19th, finance and labor ministers from the Group of 20 meet in Moscow.
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