Column: An extraordinary summer
By James Saft
(Reuters) – Put away the sunblock and beach towels, for central bankers this is going to be yet another summer of extraordinary measures.
Major central banks around the world, struggling with low growth and sagging inflation, seem to be moving towards joining their peers at the Bank of Japan in considering even more radical measures to stimulate growth.
The European Central Bank on Thursday cut interest rates and threw out broad hints about a range of unconventional measures it may pursue, without committing to anything specific. Europe’s central bank also cut its main interest rate by 25 basis points to 0.50 percent and lopped a half a percentage point off of its marginal lending facility, taking it to 1 percent.
On Wednesday the Federal Reserve kept rates on hold but inserted a key phrase into its statement which opened the door to increased or decreased bond buying if needed. While the Fed, which is divided on the need for and wisdom of more quantitative easing, or QE, was careful to keep its options open, the significant change was that it was for the first time in recent months discussing the possibility of doing more.
Despite buoyant stock markets and giddy debt markets, the global economy is in a clearly weakened state and getting worse.
It is not unfair to use the word depression to describe what is happening in the euro zone, with mass unemployment showing little sign of improving. Euro zone inflation slumped to just 1.2 percent in April, and is in outright deflation in the hardest hit areas.
The JP Morgan Global purchasing manager survey showed that manufacturing world-wide is teetering just above the line that separates expansion from contraction, with weakening conditions in all the major economies.
So what can the ECB do?
Its major problem is that too little of its easy monetary policy actually benefits businesses. That’s because Europe, an economy which is highly dependent on bank financing, is in the midst of a banking crisis and recapitalization, especially in its periphery. Even though banks can now fund their day-to-day liquidity needs cheaply, few are willing to make aggressive loans, preferring to hold government bonds.
In an economy which gets 80 percent of its corporate funding via banks, as opposed to the 80 percent via capital markets in the U.S., that is a crippling problem.
ECB chief Mario Draghi said the bank would consult with other euro zone institutions about efforts to channel credit to the real economy, particularly smaller enterprises, perhaps by jump-starting the securitization market. He also discussed the possibility of policy which would mean negative interest rates, where depositors would actually pay for the privilege of warehousing money.
None of this will be easy for the ECB to agree. While some of its members are prepared to do more, and may have argued for more this time, the Bundesbank wing of the central bank is consistently opposed.
The Federal Reserve is in similarly sticky territory. Employment remains soggy and the Fed’s favorite measure of inflation rose just 1.1 percent last month, implying both economic weakness and room to maneuver.
Interestingly, the term premium, essentially the extra interest investors usually demand for holding longer-term debt, has shrunk to zero. That may imply a bond bubble but it may also show a lack of faith in future growth, and by extension future interest rates.
On the face of it, this would seem to argue for the Fed to increase its bond buying, or perhaps to begin to purchase a broader range of assets so as to better get the stimulus to companies and households.
But while there is clearly room for the Fed to do more to hit its twin inflation and employment goals, actually doing more is going to be controversial within the Fed, implies risks to financial stability and, perhaps worst of all, is liable to be more of what already isn’t working.
The overall likelihood is that the economy continues to show weakness and by summer we are discussing yet another global slump, though perhaps a mild one. Chinese data is weak and for all the talk of the death of austerity, government spending in Europe, the UK and the U.S. will remain under pressure.
Like a going-out-of-business sale that lasts all year, at some point we may need to drop the word “extraordinary” from extraordinary monetary policy.
(James Saft is a Reuters columnist. The opinions expressed are his own)
(At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on)