MacroScope

ECB deflation risk denial has echoes of 2009

Euro zone policymakers like to talk. They often contradict each other at separate speaking engagements on the same day. But they have struck a chorus in recent weeks, asserting that deflation is not a threat.

Members of the ECB Governing Council have been particularly vocal, insisting they will not have to alter policy to counter falling prices.

Jan 9: Mario Draghi says the euro zone may “experience a prolonged period of low inflation” — steering clear of even mentioning the word deflation.

Jan 21: ECB’s Ewald Nowotny says “we neither see inflation nor do we see deflation in the euro zone”.

Jan 23: Draghi says “the risks of deflation or inflation are limited at this point in time.”

The limits of Federal Reserve forward guidance on interest rates

The ‘taper tantrum’ of May and June, as the mid-year spike in interest rates became known, appears to have humbled Federal Reserve officials into having a second look at their convictions about the power of forward guidance on interest rate policy.

Take James Bullard, president of the St. Louis Fed. He acknowledged on Friday that the Fed’s view of the separation between rates guidance and asset purchases had not been fully accepted by financial markets. “This presents challenges for the Committee,” he noted.

A decision to modestly reduce the pace of asset purchases can still leave a very accommodative policy in place to the extent forward guidance remains intact.

At the Fed, there’s a way to raise rates — but is there a will?

The Federal Reserve has kept its key federal funds rate at near-zero for four straight years, and it expects to keep it there for at least two more. But with each trip around the sun, outsiders wonder whether central bank policymakers will act without hesitation when the time finally comes to tighten monetary policy?

This week, the official with his hand on the Fed’s interest-rate lever, so to speak, asked that same question. Simon Potter, head of the Federal Reserve Bank of New York’s open market operations, was at NYU‘s Stern School of Business discussing the various ways the central bank can tighten policy: the federal funds rate; the interest rate on excess bank reserves; reverse repurchase agreements. Potter runs the unit that carries out Fed policy in the market, and sits in on most policy-setting meetings in Washington. Asked by a student about the inflationary or deflationary risks associated with tightening policy in the future, he had this to say:

The real heart of that question is a willingness one. I’m pretty confident we have the technical ability to raise rates. The hard part will be the willingness in some people’s minds. What I’ve seen among most people in financial markets is they’re pretty sure that the Fed will raise rates when it’s appropriate to do it… Definitely compared to 2009-2010, the type of hedge funds and people who took large bets thinking this would lead to high inflation have given up on that bet.

The perils of predicting BoE policy

BRITAIN/As we’ve noted extensively, economists often get it wrong. Leaving aside their collective failure to recognise an impending global recession, you might recall a shock interest rate hike from the Bank of England in January 2007.

This was another event that almost every economist polled by Reuters failed to spot, and there are signs that four years on, economists might be setting themselves up for a similar shock.

The consensus from the last Reuters BoE poll last week showed interest rates would stay on hold into the fourth quarter, even though UK money markets have priced in a 100 percent chance of a rate hike by May. Since the January meeting, some of the bank’s Monetary Policy Committee members have publicly stated their determination to fight strong inflation.

Here, there and everywhere with ECB’s Nowotny

Austria’s Ewald Nowotny is a very busy man. Apart from running the Austrian Central Bank and sitting on the board of the European Central Bank, he has given at least 32 interviews since taking office last September, to publications as diverse as Japan’s Nikkei newspaper and Austrian alternative weekly Falter as well as the usual financial papers.

And his fondness to talk at length on ECB rate policy, the euro, emerging Europe, recession, inflation, deflation, growth forecasts and bank rescues has in turn set tongues wagging. He’s even done an internet chat with readers of Austria’s Der Standard.

“Ewald Nowotny is almost omnipresent. Barely a day goes by without (him) popping up in one of Austria’s publications airing statements about the current economic situation,” German
financial daily Handelsblatt wrote in a recent article, which only appears in its paper version.

Meet Macroscope …

The financial system is in the grips of its most violent
upheaval since the 1930s. A staggering amount of wealth has been
destroyed this year — $11 trillion wiped out from world stock
markets in the past nine months. The damage already is spilling
into the real economy, and fears are spreading among investors
of a deep and damaging downturn.

Macroscope is a new blog where Reuters journalists from
around the world look behind the headlines, the speeches and the
economic reports to bring you a fresh look at the factors
driving the world economy, and the people making the decisions that affect
your household budget.

It will look at the policymakers who are ripping up the rule books
in a desperate search for ways to get cash pumping through the seized-up money markets,
stabilise banks, revive stock markets and prevent the credit
crisis from turning an economic downturn in the United States
and Europe into a deeply damaging global recession.