Although the dust has settled on recent central bank announcements, they have not resolved uncertainties about future policy direction, leaving markets somewhat confused.
The Bank of Japan appears to have merely postponed a decision to ease monetary policy further into negative territory, while the European Central Bank went much further than many had originally thought it would. But even after taking bolder steps it still managed to muddy the waters by implying that there was little chance of any further easing steps, something the markets did not want to hear.
The most confusion revolves around the Federal Reserve in the wake of Janet Yellen’s press conference this month, with contradictory viewpoints emerging from the Fed only days after she appeared to downplay the chances of a near-term interest rate hike.
The BoJ’s decision to hold interest rates steady this month may have been something of a surprise at the time it was announced, although in hindsight it was probably too early to expect another rate cut so soon after the January 28 decision to cut interest rates on excess reserves into negative territory.
The Japanese yen rally that ensued, however, did not last long, especially after the BoJ governor Haruhiko Kuroda expressed confidence in the effect of negative interest rates and argued that they could still be cut further. With inflation likely to disappoint in coming months, it seems likely that further cuts in Japanese interest rates have only been postponed, with Mr Kuroda signalling an implicit easing bias.
The ECB, on the other hand, appeared to go overboard in terms of the measures it took, but at the same time it managed to complicate matters by sending out mixed messages about the potential for taking further steps down the road.
Interest rates were cut across a range of policy instruments, monthly asset purchases were raised and there was a host of other steps, including the launch of a new series of long-term refinance operations, which will provide cheap financing to banks.
Despite all of this, the main takeaway for markets was ECB chief Mario Draghi’s comment that he does not anticipate that interest rates will need to be cut any further. Since then ECB efforts have largely been spent countering this impression, by indicating that the ECB has no shortage of tools to ease policy further, and that minus 0.4 per cent is by no means the lower boundary for policy rates. Even the use of “helicopter money” has been floated by the ECB’s chief economist as something that has not been ruled out.
The Federal Open Market Committee’s decision constituted the biggest surprise, however, as it took on a significantly more dovish tone than expected by the markets, with a statement that continued to see risks coming from global economic and financial market volatility, just as that volatility seemed to be coming to an end and as US economic activity appeared to be firming.
The surprise was less about the unchanged rates decision and the cuts to the “dot plot”, which were expected, but more about the dismissal of the rise in core inflation and the risks around Fed credibility if this continues.
Credibility is certainly becoming the key issue for the Fed, as it dominated the questions at Ms Yellen’s press conference and has also dominated much of the subsequent discussion by Fed officials. It has only taken a few days for some of those on the FOMC who had subscribed to a dovish message this month to begin raising the ante for another hike in June, or even possibly next month, with the St Louis Fed president James Bullard mentioning the risk of the Fed “falling behind the curve” if it does not move soon to normalise policy rates further.
At the very least, Ms Yellen will be harder pressed to justify her dovish stance late next month should markets remain becalmed between now and then, and the US economic data improves further, which it seems likely to do. Jobs figures are expected to have grown healthily again this month but the real test will be from inflation, which is already above the Fed’s assumption for where it will be at the end of the year.
Tim Fox is the chief economist and head of research at Emirates NBD.
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