Today’s co-ordinated action saw six of the world’s central banks agree to provide dollar funds a lot more cheaply. The European Central Bank, however, went a step further than its counterparts by lowering the margins, or haircuts, applied on the assets that borrowers hand over to the central bank in order to secure dollars.
This from the FT’s Robin Harding and Ralph Atkins:
In a further move to boost the attractiveness of its dollar offers, the ECB said it would value more favourably assets that have to be put up by banks as collateral to obtain US dollar liquidity. The current margin, or discount, applied would be cut from 20 per cent to 12 per cent.
That means that the ECB is not only willing to provide dollar funding more cheaply, but also take on more of the credit risk for doing so. This pretty much consigns the traditional way in which central banks have provided emergency funding to the dustbin.
But that may be no bad thing.
Walter Bagehot. Image by Getty.
Walter Bagehot would be turning in his grave.
A research note published by the Bank of Canada on Thursday has dared to challenge the 19th Century economist’s rule that monetary authorities should lend only at a penalty rate against good collateral in times of a liquidity squeeze.
Instead, the Bank of Canada suggests that it would perhaps be wiser for the rate charged to be cut, by lowering the haircuts set on collateral exchanged for central bank cash on signs of liquidity shortages.
The reputation of inflation targeting, which before the crisis was one of central banking’s sacred cows, has taken a bruising in recent years.
But Canada’s renewal this week of its 2 per cent target for the next five years would suggest that all was well – or at least broadly ok – with the framework.
Not so fast. Comments by Mark Carney, the governor of the Bank of Canada, highlight that if inflation targeting is to survive, then it will have to adapt.
But that could mean sacrificing some of its benefits.
The Bank of Canada is one central bank that has flirted with the idea of dropping its inflation target. Perhaps even as soon as at the end of this year.
Among the options was switching to a price-level target, an idea which Charles Evans, the president of the Chicago Fed, is also keen on.
Canada has now ruled that out. This from Bloomberg:
Canadian Finance Minister Jim Flaherty said the Bank of Canada’s mandate will remain unchanged, as the government prepares its five-year renewal of the central bank’s inflation target by the end of this year…
…”We will announce the range, of course, as we do,” Flaherty said. “Other than that, the mandate remains the same for the Bank of Canada.”
The decision by Canada, one of inflation targeting’s earlier adopters, is significant.
But, just because a price-level target is off the cards for now, does not mean that it will not be adopted at a later date.
Next week sees a host of central banks vote on monetary policy.
The Reserve Bank of Australia’s board is expected to hold rates on Tuesday. On Wednesday Sweden’s Riksbank, the National Bank of Poland, the Bank of Japan and the Bank of Canada are all set to vote.
Comments by Jean Boivin, a deputy governor of the Bank of Canada, have prompted speculation that the central bank is set to abandon its inflation target in favour of a price-level target.
The central bank, along with the Canadian government, will decide later this year whether it maintains its current monetary policy framework. And a price-level target is indeed one option up for consideration.
But is it likely to switch so soon?
Most of the world’s senior central bankers (see last year’s attendee list) will head to the wilds of Wyoming from next Thursday to Saturday for the Kansas City Fed’s annual Jackson Hole economic symposium.
Among those attending this year are ECB president Jean-Claude Trichet along with his fellow executive board members José Manuel González-Páramo and Peter Praet, Bank of England deputy Charlie Bean, and Fed chair Ben Bernanke. Fed vice chair Janet Yellen, and governors Sarah Raskin and Elizabeth Duke will also be at the event.
Canada is less positive on the world economy than at its last meeting as it continues to hold rates. “The global economic recovery is proceeding broadly in line with the Bank’s projection,” the statement said. Last month, that same recovery had been proceeding “at a somewhat faster pace than the Bank had anticipated”.
It’s not all gloomy, though. Canada’s recovery is “proceeding slightly faster than expected” this month. Still, expect interest rates to remain on hold for some time yet: It remains the case that “any further reduction in monetary policy stimulus would need to be carefully considered.”
Canada strikes a bearish note as it chooses to keep policy rates on hold, saying “any further reduction in monetary policy stimulus would need to be carefully considered”. So the target for the overnight rate stays at 1 per cent; the bank rate at 1.25 per cent and the deposit rate at 0.75 per cent.
In an “environment of significant excess supply,” says the Bank, “considerable monetary stimulus” is still required for inflation to reach its target of 2 per cent +/- 1 per cent. Headline inflation was exactly on target at 2 per cent y-o-y in the most recent November data, but it does not yet appear stable. Rather, it fell from 2.4 per cent the previous month. Core inflation, which strips out volatile components such as energy, is trailing behind its 2 per cent target at 1.4 per cent.
Merry Christmas, banks. If you start running low on dollars in the new year, your central bank will now be able to access the greenback via currency swaps just extended by the Federal Reserve. For several countries, anyway.
Temporary swap agreements, set up most recently in May with the ECB, BoE, BoJ, SNB and Bank of Canada, were due to expire in January but have now been extended to August 1, 2011. These agreements allow a central bank to receive dollars in return for their own currency, which are then converted back at the same exchange rate at a later day (be it overnight or up to about three months). It’s a liquidity-providing, cash-crunch-prevention measure.
The swap lines are essentially unused at present. Only $60m is outstanding. So why extend? Robin, who’s writing on this for the paper as I type, says the move clearly reflects concerns about Europe. That would explain the curious coincidence of a BoE-ECB swap being set up on Friday (specifically to provide sterling to Ireland).