At the end of last week we saw the European Central Bank take centre stage with its threat/promise to raise Euro zone official interest-rates at their April meeting. If you translate their code then you would now think that a rise in April from the current 1% to 1.25% was now more likely than not, although in the current volatile environment (North Africa for example) there is no such thing as certainty. One thing that the “shock” effect of their announcement did remind me of was the tactics of the German Bundesbank which loved to do the unexpected and shock markets in the 1980s and 90s. They always had you on your toes. I suspect this tactic may well be related to the current Bundesbank President Axel Weber announcing he will not stand to be the next ECB President with the ECB Governing Council feeling its credentials need a boost as the standing down of “Darth” Weber had sent the reverse message. This led to the following question in my mind.
What will the other central banks do?
As China is involved in tightening anyway there is little change for her. Japan is still mired in disinflation so again little likely change. Indeed from the point of view of Japan the rally in the Euro exchange rate which this statement produced is likely to be welcome and frankly they would like more of it! As Japan has an overvalued currency and has exporters struggling with its inflated level the Bank of Japan will welcome this new policy and an exchange rate of 115 Yen to the Euro. So in spite of their own monetary policy still being very loose and in fact pretty much the opposite of what the ECB proposes it may well raise a smile in Tokyo.
The US Federal Reserve
Here we find another central bank with a loose monetary policy. With interest-rates set in a range of 0 to 0.25% and asset purchases planned of US $75 billion per month ( until June 2011) policy could hardly be much more expansionary. Will it now change? The last 24 hours have seen 2 voting members of the Fed give speeches and one be interviewed on CNBC. As the debate starts with will QE2 (the asset purchases) now end early let us start with the most “hawkish” of the three Richard Evans of the Dallas Fed.
Richard Evans: President of the Dallas Fed
Mr.Evans first lets us know his view on the current policy known as QE2
There are some, including me, who argued against the last tranche of insurance we took out in committing to buy $600 billion in U.S. Treasuries between last November and the end of this coming June as we were simultaneously purchasing additional Treasuries to make up for the roll off in our mortgage-backed securities.
Okay Richard why do you think that?
There was a strong feeling among those of my policy persuasion that we had already sufficiently refilled the tanks holding the financial fuel businesses needed to drive their job-creating machines. They felt that by being too accommodative, we might run the risk of planting the seeds that could germinate into renewed volatility, speculation and inflation, or give comfort to a government that for far too many congressional cycles has fallen down on the job by spending and borrowing and committing to unfunded programs with reckless abandon.
Indeed he goes onto tell us this.
I do not, however, feel that further monetary accommodation will speed the process. It might well retard job creation, should it give rise to inflationary expectations or, worse, imply that,……. we have now been compromised and become a pliant accomplice to Congress’ and the executive branch’s fiscal misfeasance.
If you combine this speech with previous ones by Richard Evans it is plain that he is no fan of what is called QE2. However I see no sign in the speech of any hint that he will vote to stop it. Indeed rather oddly he actually voted in favour of it at the last FOMC meeting! Quite how he managed that feat of intellectual gymnastics I am still not quite sure but he did. Indeed he even mentions the factor that to my mind means that QE2 and QE-lite are likely to continue until they expire.
But it is worrisomely clear that the task of putting millions of unemployed and underemployed Americans back to work will take an anguishing amount of time.
Members of the FOMC are referring to this fact so often these days it makes me wonder more and more what will happen when QE2 and QE-lite end in June. If we saw the picture for unemployment and employment deteriorate there is little doubt in my mind that the FOMC would then vote for a new round of asset purchases which would no doubt be called QE3. As I expect asset purchases to suffer from the law of diminishing marginal returns there would then be serious problems as QE3’s very existence would already imply that QE,QE-lite and QE2 had not succeeded.
Just to be clear Richard Evans assures us that he would not vote for a QE3 but he previously said he was against QE2 and then voted in favour of its continuation. So here is my message to those who expect QE2 to end early. Who is going to vote for this if not Richard Evans? Of course circumstances may change but as we stand there is little sign of the improvement required.
Charles Evans: President of the Chicago Fed
Charles Evans who apparently likes to be called Charlie (sometimes you couldn’t make it up…..) was interviewed on and looking at the transcript and trying to make sense of what seem at times to be confused ramblings we get this.
That’s part of my rationale for why $600 is a good number for our asset purchase size. I– when we started this, I might have thought that, you know, $600 was a good start to the program and we might have to do more. It’s looking more and more to me that $600 is a good number for this.
I am giving him the benefit of the doubt and assuming he is aware that it is US $600 billion for QE2 rather than an amount some US $599.999994 billion smaller! However the message is clear to my mind, Charlie has only thought of more so far and not less.
In a speech which has now disappeared from the Atlanta Fed website President Lockhart told us this.
My first inclination is to be very cautious about extending asset purchases after June…………….Given the emergence of new risks, however, I prefer a posture of flexibility as regards policy options.
I think that the US Federal Reserve is sending out a message that its polices are working well and that we can expect economic growth of 4% this year and 4% in 2012 too. Accordingly this makes people wonder if the current programme of asset purchases might end early. Personally I feel that the scenario presented is rather rose-tinted and that one factor will worry FOMC members. What if they turn of the QE2 and QE-lite taps and the stock market and asset prices immediately go into reverse? What do they do then? Well might they worry in my view.
If you take my suggestion then any dip in the economy makes a further round of asset purchases possible and then probable depending on the scale of the dip. As the FOMC talks more and more about unemployment it is my view that these figures as they develop in the spring and summer of 2011 will in effect be setting US monetary policy.
The UK and the Bank of England
Here we have a central bank with a clear inflation problem. The officially target inflation index for consumer prices or CPI is at 4% which is double its target and its predecessor RPI is at 5.1%. As the equivalent inflation rate in the Euro zone is only 2.4% it is clear that were the ECB to be in charge of UK economic policy we would already have seen not only a rise but rises in interest-rates.However the Bank of England is in what psychologists would call denial and its policy could be lampooned as “inflation I see no inflation” as like Nelson they put the telescope to their blind eye!
At the meeting on Thursday there is a chance that the Bank of England will raise interest-rates as at the last meeting 3 of the 9 members voted accordingly. So it would take only 2 more votes. As an aside I wonder if it could be 4-4 this time apart from the Governor who would presumably vote for no change. However I think that whilst possible it is still a low percentage chance.
1. The Monetary Policy Committee has often placed great store on economic growth figures. The latest official figures showed a fall of 0.6% in Gross Domestic Product or GDP for the last quarter of 2010.
2. More recent economic data does mostly show a return to growth but some elements have been weaker. For example we had estimates last week that whilst manufacturing was doing well the growth in services had slowed a little. Today we see that the British Retail Consortium is reporting a drop in sales of 0.4% in February. So whilst the measures released are unreliable they may give an excuse not to raise interest-rates. We will get new figures for industrial and manufacturing output on the day of the decision so we will have to wait for them. some forecasters have been reducing their growth forecasts for 2011 presumably on the basis that 2010 ended weakly. (Personally I think that this is a mistake as we do not yet know with any clarity what did happen at the end of 2010 as there are many contradictory figures).
3. The Bank of England has invested a lot of its remaining authority and credibility in telling us that inflation is “temporary” and a result of “one-off” factors. Accordingly a policy change would be at best embarrassing….
A Wild Card
The wild card is that MPC members must be aware that they are attracting criticism which is rising and that their policy is becoming an ever larger embarrassment. Looked at like that then just like a wild animal which is cornered their behaviour is hard to predict and so I will be awaiting noon on Thursday!
A New Member of the MPC
If you were from Mars observing the UK over the period of the credit crunch you might think that it might be best to avoid appointing a banker at this time and that considering the company’s dodgy involvements around the world such as Greek debt derivatives it would be particularly wise to avoid appointing someone from Goldman Sachs.If you were willing to ignore that you might think that as ex-alumni of Harvard Business School were implementing policies which were under fire it might be best to avoid them too……… So I guess our Martian is currently wondering about this appointment!