central banks

Just when it all seemed very bleak, the global economy has shown some tentative signs of a rebound in recent weeks. The improved data significantly reduce recession risks in the near term.

Last month, in our regular report on the results of our “nowcasts” for world economic activity, we pointed to a sharp weakening in eurozone growth, leading to new lows for global growth in the recent slowdown. The US and China both seemed to be stuck in a prolonged malaise, and the world growth rate had slumped to more than one percentage point below trend.

Furthermore, momentum was negative. Economic commentators, including the IMF and the major central banks, were warning of increased downside risks to global economic projections. In fact, they are still issuing these warnings.

This month, however, the data have failed to co-operate with the pessimists.

Global activity growth has bounced back to 2.6 per cent, compared to a low point of 2.2 per cent a few weeks back. Much of this recovery has occurred in the advanced economies, with our nowcast for the United States showing a particularly marked rebound after more than 12 months of progressive slowdown.

It would be wrong to place too much importance on a single month’s data, especially when the nowcasts are heavily influenced by business and consumer surveys.

These surveys have remained mixed, but downward momentum has been partly reversed in most advanced economies, especially in the US where the regional Fed surveys for March have been identified by the nowcast models as major upside surprises. In fact, sentiment had become so pessimistic that even slightly better data have represented positive surprises relative to economists’ expectations, according to the Citigroup Surprise Indices.

These better numbers still leave the global economy growing at 0.7 per cent below trend, so spare capacity in the world system is still rising, and long term underlying inflation pressures should therefore still be dropping.

Better, but still not very good, is this month’s verdict. Full details of this month’s nowcasts can be found hereRead more

BELGIUM-EU-SUMMIT

Mario Draghi, ECP president  © Getty Images

Even central bankers can learn from their past mistakes. The package of measures unveiled on Thursday by the European Central Bank is an intelligent response to the criticisms levelled against it for the debacle of its previous, underwhelming easing in December, and against the Bank of Japan for its misguided experiment with negative rates last month.

The announcement by Mario Draghi, ECB president, represents just about the best effort that can be adopted nowadays to use unconventional monetary policy to restore inflation to target. It is not overly huge in scale, but is multi-faceted and well directed at the special problems plaguing the eurozone economy. Read more

China's Central Bank Governor Zhou Xiaochuan Holds A Press Conference

Zhou Xiaochuan, PBoC governor  © Getty Images

The long and detailed interview given by the People’s Bank of China governor, Zhou Xiaochuan, to Caixin Weekly on Tuesday is in one sense very un-Chinese. It provides a much more fulsome statement of foreign exchange policy, as viewed from the central bank, than anything available in the past. After months in which the governor has been conspicuously absent from the public fray, he has now chosen to go on the attack.

Mr Zhou sees the recent exchange rate crisis as out of line with economic fundamentals in China, and for that reason essentially temporary. He describes a new currency regime that is best characterised as a dirty floating regime, measured against the renminbi basket, not the dollar. “Speculative” attacks on that regime will be opposed and defeated by the central bank. In the longer term, the peg against the basket can be adjusted if fundamentals change, and the links between the two will be explained in more detail in the future.

This statement will further reduce the risk of a competitive devaluation of the renminbi in the near term. But does that mean that the China currency crisis is over? Read more

The risk of a large devaluation in the Chinese renminbi is once again spooking markets, which are firmly convinced that this as a very bad contingency for global risk assets in 2016. As last year ended, investors became more relaxed about the threat, following a series of veiled announcements from the PBoC about its currency strategy. These statements seemed to suggest that the central bank would broadly stabilise the effective exchange rate against a currency basket from now on, while allowing greater flexibility against a (possibly) rising dollar.

Since the dawn of the new year, however, investors have become much more concerned that a larger devaluation may be in the works, either through the choice of the Chinese authorities, or because the outflow of private capital is getting out of hand. Some bears in the currency markets believe that China could soon be suffering from a genuine exchange rate crisis, in which its enormous foreign exchange reserves could be quickly drained.

That would indeed be a severe shock to global markets, since it would effectively export the deflationary forces that are overpowering the Chinese manufacturing sector to the rest of the world, and would probably require direct measures to restore the health of the Chinese financial system. But it still seems unlikely to happen, for now at least. Read more

The latest and, so far, the most severe scare about global deflation started with the oil price collapse in mid 2014, and reached its peak with the sharp drop in global industrial production in mid 2015, swiftly followed by the Chinese devaluation episode in August. Fears of an imminent slide towards a global industrial recession haunted the markets, and both expected inflation and bond yields in the advanced economies approached all-time lows.

But, just when everything seemed so bleak, the flow of economic information changed direction. Global industrial production rallied, and China stabilised its currency. On Friday, the US jobs and wages data were much stronger than expected. Inflation data in the advanced economies have passed their low points for this cycle, and the rise in headline 12-month inflation in the next three months could surprise the markets.

This certainly does not mean that the repeated warnings of the inflationistas will suddenly be proved right. It may not even mean that long-run deflationary pressures in the global economy have been fully overcome: global growth rates are still below trend, and spare capacity is rising in the emerging world. But the peak of the latest, commodity-induced deflation scare is in the past. Read more

The extreme turbulence of the financial markets in August resulted in a temporary rise in the Vix measure of US equity market volatility to levels that have been exceeded on only a few occasions since 2008. Markets have now settled down somewhat, but it is far from clear whether the episode is over. In order to reach a judgment on this, we need to form a view on what caused the crisis in the first place.

The obvious answer is “China”. The response of the Chinese authorities to the stock market bubble, and the manner in which the devaluation of the renminbi was handled, raised questions about policy credibility that added to ongoing concerns about hard landing risk in the economy. The conclusion that a China demand shock was the main driving force behind the global financial turbulence was given added credence by the simultaneous collapse in commodity prices, and in exports from many emerging economies linked to China.

It would be absurd to deny that China had an important role in the crisis of August 2015. But was it the only factor involved? After all, China’s growth rate does not seem to have slowed very much. Furthermore, standard econometric simulations of the impact of a China demand shock on the major developed economies suggest that the effects should not be very large, and certainly not large enough to explain the scale of the decline in global equity prices, or in the “break-even” inflation rates built into US and European bond markets.

It is conceivable that bad news from China triggered a sudden rise in risk aversion among global investors that exacerbated the shock itself. It also possible that markets were responding to the fact that the Federal Reserve apparently remained determined to raise US interest rates before year end, regardless of the new deflationary forces that were being triggered by events in China.

New econometric work published today by my colleagues at Fulcrum suggest that the perception of an adverse monetary policy shock may have been important in explaining the financial turbulence, in which case the Fed needs to tread extremely carefully as it approaches lift-off for US rates. Read more

Fed Chair Janet Yellen Holds News Conference Following Federal Reserve Policy Meetings

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Last week, the Federal Reserve was forced to admit that it had mistakenly released the forecasts made by the board of governors’ economic staff for the June meeting of the Federal Open Market Committee. These forecasts are normally kept secret, until they are released with a five-year time lag.

This embarrassing error could not have come at a worse time for the board, since it is already under considerable pressure from Congress over the alleged misuse of public information in the recent past. Although there is no suggestion that this latest mistake involves any privileged access to secret information, it does mean that the Fed has accidentally made public much more information about its internal forecasts than it usually wishes to.

The rest of us therefore have more information than usual to work on. As this blog noted last weekend, the economic staff’s projections indicate a worryingly pessimistic view of the supply side of the US economy, with only a small output gap at present, and very low productivity growth in the future. If validated by future data, this pessimistic view will involve a much lower medium-term growth rate for the US economy than has generally been assumed by official and private economists, and eventually that might start to worry the equity markets. Read more

The latest results from Fulcrum’s “nowcast” models of the global economy, based on data published up to last week, indicate that the dip in global economic activity that was apparent in the early part of this year has now been fully reversed. In fact, in early July the models are reporting that underlying global activity growth has risen to 3.5 per cent, which is the highest since last November, when the Chinese and US economies both embarked on a slowdown. That now appears to have been temporary, and the world economy has resumed growing at near its trend rate.

There has been a simultaneous improvement in activity growth in many regions of the world in the past two months – including in the US, the UK, Japan and China – which increases our confidence that the pick-up in activity is genuine.

However, it is noteworthy that while US activity has now re-accelerated, the euro area has slowed moderately from the firm growth (by its own standards) reported earlier in the year. Therefore a gap of almost 1 percentage point has opened up between US (2.6 per cent) and euro area (1.7 per cent) growth, after a period in which the two regions were running neck-and-neck.

Within the euro area, there has been a marked recent slowdown in Spain, which had previously been the strongest of the major European economies. It is possible that the Greek crisis has had some effects on economic confidence in Spain, as shown in recent weakness in business survey data.

In the emerging economies, recent data have been mixed, with the improvement in China offset by pronounced weakness in Brazil, Russia and some smaller Asian economies. It is too early to conclude that the slowing in activity in the emerging economies is definitively over, but the signs are improving somewhat. Read more

LATVIA- EU-SUMMIT

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As the Greek drama dominated news bulletins throughout the first half of 2015, there was generally little impact on global financial markets, outside Greece itself. It is true that eurozone equities underperformed the world equity market after mid April, but the euro actually strengthened over this period, and the yield spreads between peripheral eurozone bond markets and German bunds widened only slightly, at least until this week.

This general aura of market calmness had consequences for the talks themselves, since it emboldened the Germans and other EU negotiators to take an even harder line with the Syriza-led Greek government. With no hint of a concession to take back to Athens, Mr Tsipras had nothing to sell to the left of his party.

Paradoxically, the fact that the markets remained quiet for months has therefore increased the chances of a major accident taking place as political nerves fray.

The prolonged period of market insouciance should not lull any of Europe’s leaders, headed towards Brussels for an emergency summit on Monday, into a false sense of security. There is no guarantee that the markets would remain relaxed in the case of a Greek default or exit from the euro. The real test starts now. Read more

 

G7 Finance Ministers And Central Bank Govenors Hold 2005 Conference G7 Finance Ministers And Central Bank Govenors Hold 2005 Conference

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This week, I participated in a discussion about the future of the global economy with Martin Wolf and Willem Buiter. The session was at the FT’s Business of Luxury summit in Monaco. Martin’s summary of the discussion appears here.

 

US-ECONOMY-IMF-WORLD BANK-BUITER

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What can we expect of the world economy over the coming couple of years? Looking into their crystal balls are Willem Buiter, chief economist of Citigroup, and Gavyn Davies, former chief economist of Goldman Sachs and now chairman of Fulcrum Asset Management. Mr Buiter was, and Mr Davies now is, a blogger for the Financial Times.

Martin Wolf: What are your central forecasts for the next two years? . . . READ MORE

To watch videos recorded at the event in Monte Carlo, go to www.ftbusinessofluxury.com. Read more

Lord Jim O’Neill, formerly my colleague and chief economist at Goldman Sachs, has just delivered his maiden speech as the new commercial secretary at the UK Treasury. He said that one of the government’s “primary objectives is to deliver a step change in the nation’s productivity”. Even for him, this represents a tough challenge. After featuring barely at all in the recent election campaign, low productivity growth has rightly become public enemy No 1.

Falling productivity growth has been an increasingly serious problem for most advanced economies since the early 2000s, when the boost from IT seems to have run out of steam. But the problem has been particularly severe since the 2008 financial crash, and the collapse in the UK since then has been much greater than in other advanced economies.

Overall, UK productivity had fallen about 16 percentage points below its previous trends by 2014, about a quarter of which might be due to faulty measurement in the official data. If the UK government is to make any inroads into the problem, it first needs to solve the “puzzle” of why the rest of this huge shortfall has occurred. Read more

Ever since the crash in 2008, the central banks in the advanced economies have had but one obsession — how to set monetary policy to ensure the maximum growth rate in aggregate demand. Interest rates at the zero lower bound, followed by a massive increase in their balance sheets, was the answer they conjured up.

Now, those central banks contemplating an exit from these policies, primarily the US Federal Reserve and the Bank of England, are turning their attention to the supply side of their economies. When, they are asking, will output reach the ceiling imposed by the supply potential of the economy?

The Bank of England has been in the lead here, with the Monetary Policy Committee recently conducting a special study of the supply side in the UK. Its conclusion was that gross domestic product is now only 0.5 per cent below potential, which implies that tighter monetary policy will soon be needed if GDP growth remains above potential for much longer.

In the US, the Fed has been much less specific than that, but the unemployment rate has now fallen very close to its estimate of the natural rate (5.0-5.2 per cent). Sven Jari Stehn of Goldman Sachs has used the Fed staffers’ supply side models to calculate that their implied estimate of the US output gap may be only 0.6 per cent, not far from the UK figure.

If the UK and US central banks were to act on these calculations, the implication would be that they no longer hold out much hope that they can ever regain the loss in potential output that has occurred in the past decade, relative to previous trends. That would be a massive admission, with an enormous implied sacrifice in future output levels if they are wrong. It would also be very worrying for financial assets, since it would draw the market’s attention to a downgrade in the Fed’s estimation of the long-run path for GDP. Read more

Yellen Discusses Monetary Policy At Federal Reserve Bank In San Francisco

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The financial markets listened to Janet Yellen’s speech on “normalising” monetary policy last Friday, shrugged, and moved on largely unaffected. It was, indeed, a dovish speech, of the type that had been foreshadowed at her press conference after the FOMC meeting in March (see Tim Duy for a full analysis). But it also spelled out her analytical approach to monetary policy more clearly than at any time since she has assumed the leadership of the Federal Reserve.

In the speech, the Fed chairwoman used the term “equilibrium real interest rates” no less than 25 times. This concept is very much in vogue at the Fed. The Yellen speech uses it to explain what she and Stanley Fischer mean by “normalising” interest rates. It was also at the centre of Ben Bernanke’s first forays into economic blog writing this week, which reminds us that it has some pedigree at the central bank.

 Read more

Yellen Discusses Monetary Policy At Federal Reserve Bank In San Francisco

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Now that the Federal Reserve has announced that its policy stance after June will be entirely “data determined”, the markets are watching the flow of information on US economic activity even more carefully than usual. Since 2010, there has been a recurring pattern in US GDP projections. They start optimistically, but are then progressively downgraded as the economic data come in.

Entering 2015, I was fairly confident that this depressing pattern would finally be overcome, but not so far. In the last few weeks, there has been a sharp downward adjustment to GDP growth estimates for the first quarter, and this has added to the market’s scepticism about whether the Fed will be ready to announce lift off for interest rates this summer. Read more

The Federal Reserve Begins Last Meeting Of 2008

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When the Brazilian finance minister Guido Mantega complained that the Federal Reserve was waging a currency war against his country in September 2010, his comments led to a wave of sympathy and concern. The Fed’s aggressive monetary easing was causing a capital flight from the US into the apparently unstoppable emerging markets.

Uncompetitive exchange rates and domestic credit booms in the EMs were the result of US quantitative easing. American monetary policy makers showed little sympathy, arguing that the US had its own domestic inflation and unemployment mandates to worry about. If the dollar fell in the process, so be it.

That episode proved short lived. The Brazilian real is now a chronically weak currency. Yet the term “currency wars” has stuck. It is now alleged that almost all the major central banks are engaged in weakening their currencies, if not against each other then certainly relative to commodities, goods and services. Read more

At the National People’s Congress in Beijing on Thursday, Premier Li set a target of about 7 per cent for GDP growth in 2015, and around 3 per cent for inflation. At present, both targets look hard to attain, especially on inflation. Economic reform remains paramount for the government, but China’s premier made clear that this could only succeed in the context of adequate growth. This will probably necessitate a progressive easing in fiscal, monetary and exchange rate policy – something that is already under way.

The Chinese renminbi’s exchange rate has weakened noticeably against the dollar in the past few weeks, raising concern that Beijing is joining the “currency wars” that are (allegedly) being waged by other major nations.

A big change in China’s exchange rate strategy would certainly be something to worry about. Not only would it mean that the deflationary forces evident in the country’s manufacturing sector would be exported to the rest of the world, it would also disrupt the uneasy truce on trade and exchange rate policy that has emerged between the US and China since mid-2014.

Fortunately, on the evidence available to date, it seems that China has changed its currency strategy in a relatively limited way, and in a manner that is difficult to criticise in view of exchange rate turbulence elsewhere in the world. Read more

The recent buoyancy in global equities has raised fears that the markets have entered a major bubble, driven by the unprecedented expansion in central bank balance sheets.

To the extent central bank asset purchases have reduced government bond yields, they have certainly brought forward returns from the future into the present, thus reducing expected returns on both equities and bonds. But this is normal in a period of monetary easing, and it does not automatically mean that markets are in a bubble. Read more

The recent rise in eurozone equities, along with a sharp further decline in peripheral bond spreads, has occurred in the face of continuing disappointing data on economic activity. Real GDP in the eurozone seems to be declining at a 2 per cent annualised rate in the current quarter, and the pivotal German economy is showing worrying signs of being dragged into the mire with the troubled south (see this earlier blog).

Markets are in one of those periods (which usually prove temporary) where they interpret bad economic news as being good news for asset prices, because weaker growth will result in easier policy from the central banks. In the eurozone, expectations are high that the European Central Bank will deliver lower interest rates on Thursday, and specific measures designed to address the provision of liquidity to small and medium sized enterprises (SMEs) in the south seem probable.

But a more radical easing in monetary conditions may prove necessary to drag the economy out of recession, and prevent inflation from falling further below the target, which is defined as “below but close to 2 per cent”. In March, the ECB staff forecast for inflation in 2014 was 0.6-2.0 per cent, which seems barely consistent with the mandate, especially as the recession shows no sign of ending and fiscal policy is still being tightened. Any other major central bank would be urgently reviewing its options for aggressive easing, and the markets could become very disillusioned if they sense that the ECB is unwilling to do the same.

So what, realistically, can the ECB do? The following table gives a fairly comprehensive list of the options which are definitely available within the mandate [A], those which might be available if the ECB chose to interpret its mandate more widely [B], and those which are clearly unavailable under any circumstances [C]:

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Kuroda gives first press conference as governor of BoJThe package of quantitative easing announced today by the new regime at the Bank of Japan is one of the largest monetary injections ever announced by the central bank of a major developed economy. The only rival for that crown is the emergency easing in monetary policy which took place in most economies in late 2008. But today’s BoJ action has not been driven by any short-term emergency. It represents a deliberate change in philosophy, and a complete abandonment of everything that the Bank of Japan has said about monetary policy in the past two decades. Those who believe in quantitative easing certainly have their experiment, writ large in Tokyo.

In effect the new governor, Haruhiko Kuroda, has imported into Japan the whole of the Federal Reserve’s post-Lehman balance sheet strategy, and he will implement it in under two years, instead of the five years or more taken by the Fed. The doubling in the Japanese monetary base over a period of 21 months is in itself remarkable. Taken together with the extension of the duration of bonds purchased from less than 3 years to an average of 7 years, the injection becomes of historic proportions.

The new strategy brings, for the first time, a real prospect of breaking the deflationary psyche which has plagued Japan for so long. But it also brings risks that the strategy might work too well, with inflation expectations unhinging the bond market. Mr Kuroda is trying to pull off a difficult trick, which is “to drastically change the expectations of markets and economic entities”, and to do so in a very particular way. Read more

The sterling exchange rate has now declined by about 7 per cent this year, thus eliminating all of the rise which occurred when the euro crisis was in full flood in 2011-12. Investors are asking three main questions about the drop in sterling. When will it end? Will it succeed in boosting UK economic growth? And could it, conceivably, lead to a full blown sterling crisis? Read more