Rate hikes taken off the agenda for central banks

Central banks continue to surprise with their aggressive actions to counteract global forces that are threatening the recovery in the world economy and that are risking a prolonged period of very low, or even negative, inflation writes Oliver ManganChief Economist atAIB.

Two weeks ago, markets rebounded on strong signals from the ECB that it would loosen monetary policy again. Then, last week, the Bank of Japan (BoJ) unexpectedly eased policy, moving one of its key interest rates into negative territory for the first time. It will now charge banks a negative interest rate for excess deposits that are parked with the central bank.

The BoJ’s action stunned markets and sparked gains for stocks and commodity prices. Its statement cited as concerns the recent financial-market volatility, further falls in oil prices, and uncertainty over the outlook for emerging economies.

The BoJ viewed these factors as “increasing the risk that an improvement in the business confidence of Japanese firms, and the conversion of the deflationary mindset, might be delayed” and may, in turn, negatively impact the “underlying trend in inflation”. The statement also indicated that the BoJ retains an easing bias: “It will examine risks to economic activity and prices, and take additional easing measures” if it judges this necessary.

Thus, the BoJ is prepared to loosen policy further, if required. Meanwhile, the US central bank also held its first policy meeting of 2016 last week. That meeting concluded without making changes to monetary policy. This was in line with the market expectations, as the Fed had only just increased interest rates in December, for the first time in nearly a decade.

The statement referred to recent market turbulence and increased global macro risks, and showed concern about these. It stated that the Fed is “closely monitoring global economic and financial developments”. As part of its ongoing deliberations, it is “assessing” the implications of these factors for the “labour market and inflation, and for the balance of risks to the outlook”. The Fed’s caution was most evident in this last sentence, as, throughout last year, it had described the risks to the outlook as being “balanced”. The statement portrays the Fed as being in an “assessing” mode, regarding its decision on when to tighten policy again.

It suggests that the Fed has concerns about tightening policy soon, because of recent market and economic developments. The statement neither ruled in nor out a rate hike at its next meeting, in March, thereby allowing the Fed to keep its options open. The Fed’s most recent set of projections, on the likely path of interest rates, was released in December. The median projection for the Fed funds rate, at end of 2016, was 1.375%, which is consistent with a 25bps rate hike in each quarter of this year. This now seems unlikely, given recent developments.

The markets are of the view that the Fed will not be able to raise rates any time soon. Futures contracts are now pricing in just one US rate hike in 2016, towards the end of the year. The easier stance on monetary policy, across the globe, has calmed markets after a very volatile first month of trading in 2016. Stock markets were down by 5% to 7% in January, but they finished the month well above their lows. Similarly, commodity prices recovered towards the end of the month, but they are still well down since the start of the year. Notably, oil prices have risen to near $35 a barrel, having fallen to close on $26 at one stage.

The likelihood is that markets will remain volatile for some time, given the uncertainty about the economic outlook. The global economy seems to have lost momentum over the closing months of 2015. Markets, though, appear to have found a floor over the past fortnight.

They will be paying close attention to the data for the opening months of 2016, to see how economies are performing. Central banks are doing all they can to ensure that the recovery in the world economy is sustained.

Source: Irish Examiner February 2^nd 2016