Central Banks’ Window to Restock Ammo Is Closing
(Bloomberg) -- The window to restock monetary ammunition is closing for the world’s major central banks.
With economic growth slowing and inflation lagging in big economies like the U.S. and euro area, a push to escape crisis-era policy settings that include rock bottom interest rates appears at risk of stalling. That will leave less firepower to fight off the next economic downdraft, threatening a prolonged downturn.
“It’s hard to argue that there will have been significant reloading by the time the next recession hits,’’ said Ethan Harris, head of global economics research at Bank of America Merrill Lynch in New York.
The outlook for the global economy and its policy makers will be front and center at this week’s meeting of the World Economic Forum in Davos, Switzerland. The International Monetary Fund is set to update its forecasts there on Monday, while Bank of England Governor Mark Carney and Bank of Japan Governor Haruhiko Kuroda are among the delegates. Both the BOJ and European Central Bank will hold policy meetings this week. Neither is expected to change its stance.
JPMorgan Chase & Co. economists illustrate the limited scope to re-arm. They estimate the average benchmark of developed-world central banks remains almost 2 percentage points below the pre-crisis level, and recent economic weakness and quiescent inflation has forced them to rein in forecasts for how much that gap will close.
They now expect the Federal Reserve to raise rates just two times this year, not the four they thought previously; they’ve pushed back the European Central Bank’s first rate increase to December from September and cut their anticipated hikes next year to two from three; and they no longer see the BOJ lifting its 10-year yield target in 2020.
Some analysts maintain central banks need to move quickly to normalize policy so that they’re better positioned to deal with the next downturn. But policy makers have generally rejected such a strategy, arguing that an economically unwarranted move to a tighter stance could bring about the very economic contraction they’re seeking to avoid.
The upshot is there’ll be less ammo for next time, something likely to worry investors. The Fed, for example, has a current rate target range of 2.25 percent to 2.5 percent, about half the 500 basis points in cuts it has made to fight past downturns.
If the ECB was facing its current outlook but with higher rates, it would be easing policy, according to Krishna Guha, the head of central bank strategy at Evercore ISI.
Still, ECB President Mario Draghi has signaled that an increase in rates is possible this year, something a growing number of investors and economists say is unlikely to materialize. Economists at HSBC Holdings Plc reckon that the ECB has missed its opportunity to tighten.
The BOJ has also refrained from taking additional action to spur prices even though underlying inflation remains near zero percent. That might reflect some political pushback against its ultra-easy policies.
"The BOJ will probably prefer to preserve its scarce ammunition," Alicia Garcia Herrero, chief economist for Asia Pacific at Natixis SA in Hong Kong, wrote in a note. That "would also protect its reputation from frequent policy changes."
To understand how much ammunition was spent in the wake of the global financial crisis, consider this: Analysts at Bank of America Corp. calculate central banks cut rates more than 700 times and bought $12 trillion of financial assets since the September 2008 collapse of Lehman Brothers Holdings Inc. Global government debt surged close to 75 percent to $66.5 trillion, they estimate.
Only the Fed has made any real progress in moving away from crisis settings, with nine rate hikes since late 2015 and by slowly reducing its holdings of securities bought during the crisis and its aftermath.
Low rates are a “fact of life that we as policy makers have to deal with,’’ Fed Vice Chairman Richard Clarida told Fox Business Network this month. “We have the tools that we think are appropriate to provide support to the economy if needed.’’
The ECB and the BOJ are in a tougher spot. Their main policy rates are in negative territory.
"European and Japanese central bankers are most at risk of having to fight the next downturn with their bare knuckles as they haven’t even started to recoup ammunition," said Joachim Fels, global economic adviser at Pacific Investment Management Co.
That could lead to “meaningful instability in foreign-exchange markets’’ during the next global slump as the Fed cuts rates to counter the downturn while the ECB and BOJ are constrained from acting, said Nathan Sheets, chief economist at PGIM Fixed Income. Investors in that case would be torn between wanting to offload dollars because they yield less and coveting them as a safe haven at a time of economic trouble.
Those diminished arsenals mean policy makers will probably have to burrow ever deeper into unconventional territory. Already, the program of asset purchases known as quantitative easing -- rolled out by the ECB, Fed, BOJ and others -- has drawn political criticism. Others question the efficacy of QE in reaching parts of the economy ailing from logjams that can’t be resolved by monetary policy.
To make matters worse, other stimulus options may also be more limited next time the global economy needs a boost.
"U.S. tax cuts, which limit space for fiscal stimulus when it is needed, and diminished capacity for international policy coordination, add to the concerns," said Bloomberg Economics chief economist Tom Orlik. "The prospect of a slower pace of rate hikes by the Fed and delays in normalization from the ECB and Bank of Japan is a reminder that, when the next downturn comes, central banks will have more limited ammunition to fight it."
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