How far will central banks go in 2009?

December 31, 2008

The year 2008 has been filled with unprecedented events and all-time lows, a financial system overhaul and global turmoil. Could the New Year herald positive re-evaluation and a positive turnaround? And in what has been a year of sleepless nights for many, will a nation steeped in debt start to curb excess?

Rate cuts figured high on the news agenda as banks undertook radical measures to stabilise the economy. Within the space of one week, Britain saw the lowest base rate since the mid-1950s, the ECB took its rate to a two-and-a-half year low, the U.S. Federal Reserve aggressively slashed rates and a 175 point reduction was made by Sweden’s central bank.

The key question remains – will governments run out of weapons to boost the economy in 2009?

Gazing into a crystal ball has never been quite this tricky, and perhaps the most accurate prediction from industry experts is that policymakers will likely find themselves strapped for more tools to combat the crisis.

To the average citizen, sophisticated financial gadgetry will not alleviate fears of rising unemployment levels and inflation worries. Borrowing costs for those whose home equity and other floating-rate loans are tied to the prime interest rate may have seen some relief from rate cuts, but the gain has been negligible for others.

Early this month, the IMF’s chief economist Olivier Blanchard opined that the host of government rescue measures may have brought global economies back from the brink of the worst financial catastrophe in more than 60 years, but did not remove it from the danger zone. Progress had been made, he conceded, but insisted it was “much too early to declare a victory.”

On November 6, the IMF cut its world growth projections to a mere 2.2 percent, emphasising the need for an immediate fiscal stimulus. “At this point, the goal should be fiscal boost of about 2 percent of global GDP,” said Blanchard. He remained optimistic that this would translate into a corresponding 2 percent increase in global growth.

Two weeks ago, Bank of England Deputy Governor Charles Bean said zero interest rates were a future possibility for Britain. Both the Fed and the Bank of Japan have adopted a near zero interest rate policy, with the former stating a willingness to keep rates low for an extended period.

It is worth noting however, that the co-ordinated round of rate cuts by central banks worldwide in October did not have the desired immediate impact on the state of the financial system.

Until market risk aversion eases, lowered interest rates may not impact the economy to the extent that governments would like. Additionally, as banks further their attempts to deleverage, we may very well see small bursts of stability, but a period of sustained growth seems unlikely to return in 2009.

In the interim however, we can certainly hope that some confidence is returned to both frazzled consumers and strained financial markets alike. And while extensive borrowing and emergency measures will increase countries’ debt, shoring up resources to prop up the global economy is set to be the overriding priority for a long time to come.

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