Major central banks set to go their own way, with some risk

January 9, 2015
Real interest rates of world's major central banks

Real interest rates of world’s major central banks

The world’s major central banks have long followed the same general flight path, guided by the economic winds of growth, inflation and financial markets. It has worked pretty well for policymakers in the United States, Europe, Japan, and the United Kingdom: moving together to tighten or loosen monetary policy makes things more predictable for citizens, businesses and investors. It also serves as buffer to any volatile currency movements, at least among developed economies. But six years after the worst recession in decades, this could be the year central bankers split off and – with some risk – go their own way.

While the U.S. Federal Reserve and Bank of England are expected to raise interest rates in the next 6-12 months or so, emboldened by strong jobs growth in their respective countries, the European Central Bank and Bank of Japan are headed for yet more monetary stimulus to fend off deflation and stagnant growth. Plunging oil prices, while good in principle for these importing economies, is nonetheless unwelcome for ECB and BoJ policymakers trying desperately to boost prices with low rates and massive asset purchases. Boston Fed President Eric Rosengren, speaking in Wisconsin on Thursday, noted that the ECB is expected to expand its balance sheet later this month. Taking stock of the four central banks, he said:

“Two of those central banks are going to be moving in a way that’s easing. The two that have somewhat higher inflation rates – the UK and the United States – are central banks that are currently considering when it would be appropriate to tighten. That’s pretty unusual. There is a tendency for central banks to be moving not exactly in sync, but moving in the same general direction… Basically everybody’s at zero (short term rate), but there’s likely to be a divergence (and) if you start having short term interest rates moving in different directions, you’re going to get a very different exchange rate dynamic. That’s one reason that the dollar has been appreciating so much,” with funds moving to the United States, which, Rosengren said, “complicates some of our exit strategy… Normally the exchange-rate dynamics, while they can be a little bit tricky as you start exiting, they can be even trickier if central banks are in a different position this time than they normally are.”

 

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