The central banking wars of 2016 are being fought in the currency markets

Today the Bank of England announces its monetary policy decisions. In this era of leaks and early wires it is a particular shame that it voted yesterday as this morning some are no doubt more equal than others. Although in the arena of interest-rates this may not be that big a deal as after all it is 7 years now since they changed Bank Rate.  Also Governor Carney is probably weary and to tired for another u-turn after competing in the ski marathon in St. Moritz at the weekend. However Sir Humphrey Appleby might  describe as masterly inaction has consequences if we move to the currency markets and look at the UK Pound’s response to a slowing economy.

UK Pound £

The stronger phase for the UK Pound £ has faded and been replaced by falls. In the media the falls are currently being blamed on Brexit risks and any rallies ignored. In round numbers it has fallen from the US $1.49 of late 2015 to US $1.43 now but in many ways more remarkably from 1.36 against the Euro to 1.27 now. The latter is more remarkable because Mario Draghi and the European Central Bank have only recently cut interest-rates and added an extra 20 billion Euros a month of QE asset purchases to help drive the Euro lower.

The UK trade-weighted or effective exchange-rate has fallen from 90.42 to 85.42 in 2016 so we have under the old rule of thumb the equivalent of a Bank Rate cut of 1.25%. Quite a difference to the actual rate! Also the 5 year Gilt yields ( think fixed mortgage rates) has fallen from 1.35% to 0.84%. So there you have it financial markets have eased policy for Governor Carney whilst he waffles along with Forward Guidance Mark 15.

The US Federal Reserve

Last night Janet Yellen and her colleagues on the US Federal Reserve gave us their thoughts. There was after the consumer inflation report an opportunity to be hawkish and even to raise interest-rates. Whilst the media obsessed on a monthly fall there were rises in the services area of 3.1% in annual terms telling us what will happen as the good price disinflation fades. But instead we got this.

However, global economic and financial developments continue to pose risks.

This scapegoating by central bankers has been repeated this morning by the Swiss National Bank on that subject what is Swiss for “Johnny Foreigner” please? But of course as we all live on the same planet you find that in the arrow points back at you. The net effect of all this was that now the number of interest-rate rises promised by the Fed has dropped from the rather odd “3-5” to a maximum of two.

The US Dollar

This dropped like a stone giving us an easing of US monetary policy if sustained. In a way the most remarkable move was against the UK Pound which had fallen to below US $1.41 in response to the UK Budget news. Suddenly the only way was up for the UK Pound as it bounced to US $1.43 and pretty much went back to where it began as Janet gazumped George.

If we move to the trade weighted Dollar Index we see that it fell to 95.1 so that we note that in 2016 it has fallen in broad terms from 99 to 95. Whilst this is not the measure used by the Federal Reserve Stanley Fischer gave us a rule of thumb last November which indicates that if this continues there will be around a 0.5% boost to Gross Domestic Product or GDP.

Adding in the impact of bond yields shows a further easing as it is the 30 year yield or long bond which impacts on US fixed-rate mortgages and it has fallen from 3.03% to 2.66% so far this year.

An odd mix is it not where the Bank of England has found policy loosened for it and the US Federal Reserve which is supposed to be tightening has eased as well?!

Where have currencies tightened policy?

The Euro

Mario Draghi must be crying into his glass of Chianti as he reviews a Euro exchange-rate that has pushed up above 1.13 versus the US Dollar this morning. In fact it is going up as fast as economist can predict it is heading for parity. I pointed out earlier the rise of the Euro versus the UK Pound £ as Mario surveys failure on more than one front.

The trade-weighted exchange-rate tells us the story as the recent nadir was 90.4 in late November and it started 2016 at 92.7. With all the easing it should be lower right? Er no as the ECB had it at 94.14 yesterday and as it used a US Dollar exchange rate of 1.106 a large upwards move can be expected today. After all his monetary policy easing Mario Draghi may well get out his copy of Alice In Wonderland.

My dear, here we must run as fast as we can, just to stay in place. And if you wish to go anywhere you must run twice as fast as that.

Bank Pictet estimate that the latest ECB easing will add around 0.3% to inflation. Whereas a rise in the effective exchange rate from 89.7 to 95ish over the past year will probably subject more than that.

The Yen

If there is upset in Frankfurt well that must be a tea party to how current foreign exchange developments are seen in Tokyo! Economic policy or Abenomics is essentially predicated on a lower value for the Japanese Yen and this weeks announcement of only minor changes to monetary policy has found the same response as the interest-rate cut to -0.1% which is a stronger Yen. That is also supposed to support the rise in inflation to the 2% target whereas in fact a rise of 8% over the past year means that it is cutting inflation. A problem for Abenomics and its many media cheerleaders – readers may like to note they seem to have gone quiet – if not for Japanese workers and consumers.

Of course the Bank of Japan is also concerned with the competitive devaluations going on in Asia so let us look at its trade-weighted exchange-rate. According to the Bank of England it has risen from 128 to 135 in 2016 so far. So all that easing and monetary policy has tightened via the exchange rate. Time to move from trillions to Quadrillions? So far it has all been a BitterSweet Symphony.

I’ll take you down the only road I’ve ever been down
I’ll take you down the only road I’ve ever been down


As we stand central banks are like Janus as they try to look in two directions at once. However the old rule of monetary policy that you can only look at the internal economy or the external one is coming bank to haunt our supermen and wonder women. As fast as they move policy they find that their exchange rate is mostly offsetting it and sometimes more than negating it. But still they plough on. Over to you Norway.

At its meeting on 16 March, the Executive Board decided to lower the key policy rate by 0.25 percentage point to 0.50%.

Oh and what is it with Scandanavians and negative interest-rates?

Should the Norwegian economy be exposed to new major shocks, the Executive Board will, however, not exclude the possibility that the key policy rate may turn negative.

Seems a bit after the Lord Mayor’s Show now the oil price has shown signs of stability.  Also this happened.

Norway cuts rates&…krone strengthens!




15 thoughts on “The central banking wars of 2016 are being fought in the currency markets

  1. Great blog as usual.
    It seems to me that:
    1. The “laws” of economics don’t seem to apply any more. QE/negative interest rates do not appear to stimulate anything in the real economy. Lower exchange rates do not boost exports;
    2. The markets don’t react as you would expect, either (see above);
    3. The whole model of running large government deficits is predicated on permanent growth;
    4. QE is a way of kicking the can down the road, as government deficits can be financed without taxing anyone.
    I draw two conclusions from this:
    1. It will end in tears; and
    2. They will have to rewrite most economics text books.

    • James,

      I agree wholeheartedly on 1,2,4 and your conclusions.

      You could expand point 3 to make a broader point
      permanent growth is predicated upon bank led credit expansion which in turn is predicated upon asset inflation(particularly in the housing market).

      These virtuous circles are great on the way up during the party phase but tend to have a mind of their own on the way down from the coke high when asset deflation creates balance sheet contraction which feeds the downward spiral.

      Let’s remember that in the opinion of our CB overlords,2% price inflation is the ultimate in stability …until of course it isn’t……

  2. Hi Shaun
    Politics , politics, politics. Yellen had/has the numbers she needs for a rise. However its election year, and the ‘independant Fed’ , currently stuffed with Democrat staffers, is under orders not to further risk a downturn. June was always the more likely date for the next increase, its possible a 0.5% hike could happen sometime in the year.
    Must be a big demand for those high denomination Euro notes!

    • Hi JW

      We could get a rise in both April and June if they want to reinforce the message of two rises this year. I agree that the Fed will want to avoid raising around election time – especially Brainard who has contributed to the Clinton campaign in what I consider to be a brain dead move – and this could rule out September. Or as you say all in one go in June.

      Perhaps the claim they might get rid of the 500 Euro note has created a demand for them as in get them whilst you still can! It would be quite an own goal if true.

    • Or it could be the combination of the Kitchin cycle and Kuznets cycle looking like they’re impacting together this year into their downturns, which, when coupled with collapsing narrow money supply which started last summer leads to 1 inevitable conclusion.

      Politics has nothing to do with it. It all rests on the confidence of the US consumer now.

  3. As has often been argued on here by many posters,this will all end in some sort of currency crisis.

    Currency wars have become proxy debt wars from what I can see.Look at the emerging market economies being strangled by dollar denominated debt problems.

    You then have govts-like the UK- running fiscal deficits to finance spending which is all entirely possible while sterling holds.But when it doesn’t,all hell could break loose.At which point of course all the nodding heads at the boE will be saying ‘noone could have seen it coming’,this is a global problem’ etc etc.

    • Indeed – no-one could have seen this coming will be the standard refrain. That may be true, but then what is the point of all these highly paid people in the first place?
      It reminds me of the auditors of the banks in 2008. Every single bank had a clean audit opinion (which is based on a going concern basis) and they all need to be bailed out. Did the audit firms:
      1. Get sued?
      2. Refund their fees?
      3. Carry on as usual with their rather agreeable life styles?
      You may decide which of the three.

      • ‘but then what is the point of all these highly paid people in the first place?’

        I come on here and ask myself the same question most days.

        If you watch The Big Short,I love the bit at the end where they talk about the fact that one person got jailed for all that fraud.That was it.

        White collar crime pays out like a blue chip dividend.

        • The Big Short was great, I thought, but I couldn’t take the idea that the people making the money out of shorting (rather than the banks, who took fees) were almost seen as philanthropists in the film. I am pretty sure that they were hard as nails…
          I think that one person jailed in the Big Short is probably one more than those jailed in the UK…

    • It is a global problem of currency wars Dutch. What no one seems to see in this globalised world is that with no one good or service is being entirely produced in one country (i.e. goods and services are partially created in 1 country, exported to another where some more work is performed on them, then they are exported to another country where more work is performed on them, then they are exported to another country where the good/service is finished, then they are exported to the consuming country where a final wholesale and retail service is performed) this makes a “competitive” currency devaluation in one country not particularly competitive as only one small part of the added value of the product/service is affected.

      Welcome to globalisation.

  4. Hi Shaun

    The use of the word “war” in your headline implies a strategy and an organised way of proceeding. Wars have a tendency to descend into chaos and it seems to me that we have the chaos now and the central banks are making everything up as they go along.

    These currency wars used to be called “beggar my neighbour” policies, a zero sum game which ultimately benefited no one and were pointless in the absence of a rational international framework for managing these things sensibly. I’m sure you’re aware that there are those that believe that the IMF wishes to create a new international monetary system based on SDRs which would, I assume, be at least a partial return to the Bretton Woods type fixed exchange rate structure that was effectively abandoned by the US in 1971. Perhaps you could comment on this.

    • Hi Bob J

      True although the “war on terror” has been chaotic from beginning to end. As for the currency wars there was a brief burst of farce earlier when the Bank of Japan began checking markets as the Yen strengthened into the 110s and then later asked why the Yen had weakened. It was you matey! Last time they got into the 112s,113s etc but so far around 111.5 is it so they may have to go again.

      That is the problem of setting fixed exchange rates to an IMF SDR as of the main players we would have China, Japan and the Euro area all wanting a weaker currency. The US may be the only country not to bothered and the more I think about the Euro area the more trouble I can see as the whole concept would be rather pointless. Also the stresses would simply emerge elsewhere.

  5. It is not just an economic problem. The CBer’s bosses are responsible for overspend. As Micawber recorded all those years ago, spending more than than you earn is a route to misery.

    Denial of the need to balance budgets is likely to destroy many social safety nets and defined benefit pension schemes. I agree with James, it will end in tears.

    • Hi ExpatInBG

      That is true although the central banks are funding some of this by keeping bond yields low. It was noticeable yesterday in the RBS chart that I posted that in spite of the rise in the UK National Debt the interest on it had barely risen. some is low inflation but a lot is low nominal yields.

      If we move to the Euro then the QE and “everything it takes” support to to bond yields of Italy means its government gets an annual windfall which of course it promptly spends. In the end it is inflationary but of course the numbers do not pick it up.

      • Yes, they’re funding it temporarily, sorry I just cannot believe it is sustainable.

        We don’t really need to cut benefits harshly. Ken Clarke set the BOE rates, without having a committee of 9 supposedly independent lackies paid upto 800,000 GBP each.

        It’s a pity that boy George cannot deliver his promised “Bonfire of the qangos”

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