Central Banks Commit to Ease as Threat of Lost Decades Rises
Central bankers are finding it easier to support their economies than to spur expansion as the prospect of Japanese-like lost decades looms across the developed world.
Another round of loosely correlated global stimulus has begun after the Federal Reserve extended its Operation Twist program and counterparts from Japan to Europe consider more monetary easing of their own. The Bank of Israel today joined those injecting stimulus by reducing its benchmark interest rate for the first time in five months, in part to insulate its economy from “potential negative consequences” elsewhere.
The rub is that even as they renew their rescue efforts, policy makers are postponing forecasts for fuller recoveries and run the risk that their latest actions pack a smaller punch. This raises the prospect of longer-term anemic expansion akin to the doldrums Japan has suffered since the early 1990s.
“Japan’s experience shows central banks can mitigate the worst effects of the current environment, but it’s going to be very hard for them to stimulate demand,” said Peter Dixon, global equities economist at Commerzbank AG in London. He predicts a lengthy period of “sluggish growth and high unemployment” in the debt-ridden industrial nations.
The combination of economic weakness and policy indecisiveness leaves Jan Loeys, chief market strategist in New York at JPMorgan Chase & Co., recommending gold and U.S. assets, on the hope of greater quantitative easing, and shying away from peripheral Europe’s bonds and stocks that traditionally benefit from output growth.
Ready for More
Investors should “position for further monetary action, even if it doesn’t do enough,” said Loeys, whose colleagues anticipate worldwide expansion of 1.4 percent this quarter -- the weakest since the end of the 2009 recession.
One drawback is that the central banks with the most ammunition, such as the European Central Bank and some in emerging markets, are hesitant to act, he said. India unexpectedly chose not to reduce its 8 percent benchmark repurchase rate last week, while Loeys notes other developing nations aren’t cutting because their currencies have weakened and they fear creating asset bubbles.
“From a global point of view, those willing to do something probably don’t have a lot of impact, and the rest who can do something are reluctant,” he said.
Five Years In
Almost five years after central banks first sprang into action to buoy the world economy, they are being forced to react to a third successive annual fading of recovery hopes as Europe’s debt crisis threatens to engulf Spain and Italy, hiring in the U.S. stalls and China slows. A June 1-5 poll of economists by Bloomberg News found the median estimate for growth worldwide this year falling to 3.2 percent from the May forecast of 3.4 percent.
Developed economies are running into the limits of monetary policy, the Bank for International Settlements said in its annual report yesterday. Central bank balance sheets now contain $18 trillion of assets, about 30 percent of global gross domestic product, double the ratio of a decade ago, and interest rates are as “low as they can go,” the BIS said.
Governments have “cornered” central banks into prolonging stimulus, and have dragged their feet on restoring fiscal order, said the Basel, Switzerland-based BIS. Monetary policy only “buys time” in the short run for leaders to act, and leaving an easy stance for a prolonged period poses economic risks, it said.
Memphis, Tennessee-based FedEx Corp. (FDX), operator of the world’s largest cargo airline, said last week that first-quarter profit will be lower than analyst forecasts amid slowing global expansion. Profit excluding some items for the three months through August will be $1.45 to $1.60 a share, compared with an average estimate of $1.70 from 16 analysts surveyed by Bloomberg.
The slow growth has helped blunt any inflationary threat. Oil tumbled last week below $80 a barrel for the first time in eight months, and commodities entered a bear market as the Standard & Poor’s GSCI Index of 24 raw materials fell to its lowest level since October 2010.
Fed Chairman Ben S. Bernanke and Treasury Secretary Timothy Geithner have argued that the world’s largest economy won’t suffer a fate similar to Japan, partly because U.S. policy makers have been quicker to act to promote expansion and bolster the banking system.
Even so, both the Fed and White House repeatedly have scaled back growth forecasts since the recession ended in June 2009. The latest cut came last week, when the central bank lowered its projections for this year and next. Fed officials cut their central-tendency estimate for 2012 gross domestic product growth to 1.9 percent to 2.4 percent from 2.4 percent to 2.9 percent in April. Estimates for 2013 are for 2.2 percent to 2.8 percent, compared with 2.7 percent to 3.1 percent.
“Like many other forecasters, the Federal Reserve was too optimistic early in the recovery,” Bernanke said at a June 20 press conference, citing, among other things, headwinds from the turmoil in Europe, still-tight credit for many borrowers and budget cuts by state and local governments.
The U.S. has grown about 0.2 percent on an annual basis since 2008. In inflation-adjusted terms, GDP per capita in 2011 was 2.4 percent below 2007, according to International Monetary Fund data. The recession began in December that year.
The Fed responded last week by extending its Operation Twist program through year-end, pledging to swap $267 billion in short-term securities with longer-term debt. Bernanke also signaled that the central bank is inclined to do more to spur growth should the recovery falter further or unemployment start to rise. The jobless rate has been above 8 percent since February 2009.
The ECB also is downgrading its outlook before meeting on July 5. President Mario Draghi said June 15 the 17-nation economy faces “serious downside risks” and conditions have worsened since the ECB estimated June 6 that the euro zone would contract about 0.1 percent this year. The central bank ended last year projecting growth of about 0.3 percent, a percentage point lower than it forecast in September 2011.
A contraction of about 0.5 percent is more likely, according to new forecasts from BNP Paribas SA. Euro-region manufacturing output shrank at the fastest pace in three years in June, data showed last week.
That backdrop is enough for policy makers to cut their key interest rate by 25 basis points next week to a record low of 0.75 percent, said Ken Wattret, chief euro-zone market economist at BNP Paribas in London. He isn’t ruling out a deeper reduction -- or the ECB cutting its 0.25 percent deposit rate to prompt lenders to loan more -- if European leaders meeting in Brussels June 28-29 devise a stronger response to the debt crisis.
“Is it going to turn the economy around? Clearly not, but every little thing helps,” Wattret said.
Attendees at the summit will discuss ways to better integrate their currency bloc by pursuing closer fiscal ties, adopting initiatives to bolster growth, providing stronger supervision and reinforcement for banks and perhaps issuing joint debt at some point.
Bank of England Governor Mervyn King will push at the July 5 meeting for more stimulus after being defeated 5-4 in a vote this month against greater QE. King backed increasing asset purchases by 50 billion pounds ($78 billion) and said June 14 that the central bank will activate a sterling-liquidity facility to aid banks and start a credit-easing operation that may boost lending by 80 billion pounds.
HSBC Holdings Plc and Societe Generale SA now predict the BOE will announce an increase in purchases next week, having previously said the bank would wait. The U.K. flopped back into recession in the first quarter, and King describes the euro crisis as a “black cloud” hanging over the world economy.
Bank of Japan policy makers also will review their projections when they convene July 11-12, three months since they forecast GDP would expand 2.3 percent and inflation excluding fresh food would accelerate 0.3 percent in the fiscal year that ends next March.
Analysts from UBS AG to Jefferies Japan Ltd. predict the BOJ will boost its asset-purchase program from the current 40 trillion yen ($498 billion). Board members may add more risk securities such as exchange-traded funds and corporate debt, along with government bonds, according to JPMorgan Chase.
The worry for international policy makers is that Japan’s recent past reflects their future. Its economy stagnated in the early 1990s after the BOJ boosted borrowing costs to rein in a surge in inflation, real-estate and equity prices. With banks hobbled by bad debt from the bursting of the asset bubble, the BOJ lowered its main rate to near zero in 1999.
After flooding the banking system with cash from 2001 to 2006, the central bank now has deployed its second round of QE. The moves haven’t ignited growth, with GDP rising at an average rate of 0.75 percent in the past 20 years, according to IMF data. Consumer prices fell in eight of the past 13 years, and inflation hasn’t exceeded 1 percent since 1997. Unadjusted for price changes, the size of the economy last year was the smallest since 1990 and had contracted 10 percent from its peak in 1997.
ECB economists say the U.S. and euro-area are “rather unlikely to tread the same path of Japan” because they had different pre-crisis debt imbalances, according to their May monthly bulletin. Japan’s experience nevertheless demonstrates the importance of repairing financial sectors before trying to generate a sustainable recovery and shows that delaying reforms may mean fragile economic growth, they wrote.
Central bankers say they still pack a punch.
“I wouldn’t accept the proposition” that the Fed “has no more ammunition,” Bernanke told reporters June 20. “I do think that our tools, while they are nonstandard, still can create more accommodative financial conditions, can still provide support for the economy.”
At London-based hedge fund SLJ Macro Partners LLP, managing partner Stephen Jen said he fears “we may be four years into a decade-long global crisis,” adding that rather than a lost decade, Japan now has suffered a lost generation.
Jen, a former IMF economist, questions the power of easier monetary policy and says officials must take a longer-term view and ensure their economies live within their means rather than continue dispensing short-run aid. While QE can boost equities and cap interest rates, costs include fanning medium-term inflation, sparking financial volatility and encouraging complacency among governments on structural and fiscal reforms, he said.
“After four years of policies centered around demand rather than supply, I suspect the world could be further away from a lasting solution to the crisis,” he said. “A series of short-term solutions could lead to the wrong long-term solution.”
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