Two Holds, Nine Cuts, One Hike – Now What?
Monetary accommodation was on the rise in May. Of the twelve major bank meetings during the month, nine resulted in cuts, two central banks held policy steady, and only one actually increased rates to control inflation.
While the Federal Reserve didn’t change direction, it sent mixed messages regarding its quantitative easing (QE) program. The minutes from the April-May FOMC indicated willingness to “increase or reduce” the pace of QE, a change from previous meetings that were primarily focused on QE reduction aspects. However, subsequent media reports and Fed speaker comments during public events suggested that tapering/withdrawal of QE has been a dominant occupant of the Fed mind-space recently. Also on hold was the Bank of England, who left their QE stimulus program unchanged since recent data improvements have given them room to stay put. Mervyn King, the outgoing chief, again pushed for increasing the bond-purchase program, but was defeated a fourth successive time (probably not the best way to end a ten-yr reign!).
The European Central Bank came out swinging, cutting its main refinancing rate by 25 basis points (that’s 0.25%) to land at 0.50%. The ECB also cut its marginal lending facility rate by 50 basis points to 1%, and their deposit facility rate was unchanged at 0%. When considering the cuts, the ECB focused on low inflation and the spreading economic weakness to core Europe. There was strong consensus in the 23-member council for the cuts (just a single dissention). In fact, some even wanted a full 50 basis point reduction to the main refinancing rate. Another key message was ECB chief Mario Draghi’s openness to negative rates on excess deposits placed with it by Eurozone institutions – a sign that he really wants banks to start putting their extra liquidity to work, especially to the SME sector.
The Reserve Bank of Australia cut its cash rate by 25 basis points to an all-time low of 2.75% to support demand (the Aussie PMI collapsed in April to a post-crisis low of 36.7). Subsequently, at their June meeting that just happened, they left the cash rate at 2.75%. The Danish central bank cut its benchmark rate 10 basis points to 0.20%. The Reserve Bank of India made a couple of cuts – the repo rate by 25 basis points to 6.25%, and the reverse repo rate by 25 basis points to 7.25%. That makes the third cut in this easing cycle. RBI also reduced its GDP growth expectation for fiscal year 2013 to 5.7% and expects inflation around 5.5% this year. The Bank of Korea surprised market consensus and cut its benchmark rate by 25 basis points to 2.50%, succumbing to pressures to revive domestic growth and curtail currency appreciation relative to the yen. This marks Korea’s first cut since October of 2012. Other central banks cutting policy rates included Thailand, Hungary, Poland, and Israel – each by 25 basis points.
And who hiked rates in May? Banco Central do Brasil (that’s Brazil’s central bank, of course) hiked rates during the month. This was the second increase of late, but this time was more aggressive – a 50 basis point hike aimed at containing inflation expectations.
On balance, monetary policy will likely remain accommodative around the globe. We don’t expect central banks to reverse policy course any time soon since inflation expectations are reasonably contained in most areas. ECB could get into the area of negative deposit rates if growth slows dramatically and Signor Draghi makes good on his earlier statements. In doing so, his primary intention would be to weaken the euro and force banks to lend more aggressively. In China, policy stance should remain pro-growth, but with constant fine-tuning of macro-prudential measures to keep both property prices and shadow-banking under leash. A gradually appreciating currency is likely to be their preferred tool in encouraging the shift in economic balance towards consumption from investment.
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