I’ve been thinking about what Fed chairman Ben Bernanke said in his press conference about reinvestment of maturing assets from the Fed’s portfolio.
“At some point, presumably early in our exit process, we will – I suspect based on conversations we’ve been having around the FOMC table it’s very likely that an early step would be to stop reinvesting all or a part of the securities which are maturing. But take note that that step, although a relatively modest step, does constitute a policy tightening, because it would be lowering the size of our balance sheet and therefore would be expected to essentially tighten financial conditions.”
If it is the stock of Fed assets that matters, as the Fed believes, there is no doubt that this is literally correct. Reduce the size of the balance sheet and you tighten monetary policy.
But the direct tightening would be incredibly small. I think a much more pertinent reason for Mr Bernanke’s comments is to send a signal that short-term interest rates are going to stay low and discourage the market from pricing in an earlier tightening.
Who can stop him now? Bild, Germany’s mass-market newspaper, has done a volte-face and backed Mario Draghi as the next European Central Bank president. The Italian central bank governor is pictured on page 2 of today’s edition wearing a awkward smile and a Prussian spiked helmet. According to Bild, Draghi is now being backed privately by Angela Merkel (as the FT has written).
Bild’s past opposition to an Italian having control over Germans’ currency was previously seen as a big obstacle to Draghi’s chances (not, of course, that the Berlin government is swayed by such things). Today Bild asks: “But how Italian is Draghi really? At second glance he is rather German, even really Prussian.” Bild praises him for his toughness (his parents both died when he was young), his focus and down-to-earth character. As a result, “Bild awards him honorary German citizenship”.
Central bankers like to think of themselves as brothers, doing roughly the same things, with roughly the same tools and communicating in roughly the same way. This is roughly true.
But there are important differences.
On monetary policy, the ECB is clearly an outlier. And the communication techniques of the Federal Reserve and the Bank of England are also interesting.
Robin has written about what we learned from Fed’s first first press conference yesterday, which is online in video form. I will give a few thoughts on how the Fed’s innovation compares with the Bank’s quarterly inflation report press conferences, which I have been attending since 1998.
Dumb traditions. Both banks have their peculiar silly traditions which undermine the credibility of the Fed chairman and BoE governor.
Ben Bernanke’s first press conference went pretty smoothly: I doubt there was a single question that the Fed will not have anticipated. It was also informative. I came away having learned or confirmed several new things about Fed policy.
The Fed’s forecast is that Q1 growth was below 2 per cent
“We haven’t seen the GDP number yet, but we, like most private-sector forecasters, are expecting a relatively weak number for the first quarter: maybe something a little under 2 percent.
Most of the factors that account for the slower growth in the first quarter appear to us to be transitory. They include things like, for example, lower defense spending than was anticipated, which will presumably be made up in a later quarter, weaker exports — and given the growth in the global economy, we expect to see that pick up again — and other factors like weather and so on.”
Rates are held, as expected, and QE2 is expected to continue till June. But all eyes will be on Bernanke for any signals of change at the new press conference (see video). For live blog commentary, see Gavyn Davies‘ real time post or his earlier thoughts.
Interest rates are likely to linger for longer at their current record low of 0.5 per cent, following today’s growth figures. With GDP numbers coming in at expectation, market expectations haven’t shifted that much since yesterday, but over the past two months, the change is dramatic (see chart).
Just two months ago, markets forecast three rate rises this year; now the base rate is not expected to reach 0.75 per cent until November. The data also belie an assumption that a rate rise is far likelier in a month following a GDP announcement (notice the jump in expectations for August, November and February).
With Mario Draghi, Italy’s central bank chief, looking almost certain to become its next president, the European Central Bank is set for a significant change of style – but not necessarily in strategic direction.
Under Jean-Claude Trichet, whose eight-year mandate expires on October 31, the ECB secured an inflation-fighting reputation in the tradition of Germany’s Bundesbank. During the eurozone debt crisis, the central bank acted as a crucial backstop, pumping liquidity on a huge scale into the banking systems of Greece, Ireland, Portugal and Spain. More recently, it has taken a much tougher line in insisting politicians take action themselves.
For those wanting a primer on how to interpret the 0.5 per cent rise in UK GDP in the first quarter this morning, you could read this piece from the FT yesterday. But I will also summarise the maths and its implications here.
The 0.5 per cent figure suggests the economy stagnated at best in the six months between the third quarter of 2010 and first quarter of 2011 and probably contracted a little. The stagnation bit is easy to see, since the level of GDP in Q3 2010, with an index number of 99.6, is the same as that in Q1 2011.
The “at best” bit comes from the fact that some of the activity that would have taken place at the end of last year, but was disrupted by the snow – distributing goods or maintenance of equipment for example – will have taken place in the first quarter, flattering the latest figures. We don’t know how big this effect was, but can put boundaries on it. At best, the economy stagnated. At worst, if all of the 0.5 per cent of activity lost in the fourth quarter was displaced into the first quarter, the underlying level of activity is now 0.5 per cent lower than that in Q3 2010.
No-one could accuse Andrew Sentance of leaving the MPC without making his position clear. The Bank of England’s chief hawk has just laid bare four key differences between his rate-raising position and that of the rate-holding majority on the MPC.
Disagreements on the UK’s rate-setting committee are fundamental, he says first. In the past, they have been a matter of timing. “I acquired my hawkish mantle much earlier [than last year], when I voted in a minority on a number of occasions to raise interest rates in response to the relatively strong growth and rising inflation we were experiencing before the financial crisis,” he says. “Those minority votes, however, were the expression of modest differences in the timing of interest rate changes.”
This time, the differences are directional. At their root lie contrasting assumptions about the global economy, and disagreement over economic models. Mr Sentance is due to leave the Committee at the end of next month, but the differences he describes are likely to survive him.
In comparison with the rest of the committee, Mr Sentance seems more optimistic on the global recovery, more doubtful about the use of the output gap as a policy tool, and more flexible on sterling appreciating. He is also worried about inflation expectations.
One of the most surprising US economic developments in recent months is the sudden decline in the unemployment rate from 9.8 per cent in November to 8.8 per cent in March. The reasons for it have profound implications for monetary policy. If you think this rate of decline is sustainable, than you quickly reach levels where monetary policy needs to tighten.