Friday, July 6, 2012

Coordinated uncoordinated monetary policy action

Last night saw a burst of seemingly co-ordinated but officially uncoordinated monetary policy action out of a number of central banks.  The European Central Bank (ECB) cut its main financing rate to 0.75% and its deposit rate to zero, the Bank of England (BoE) increased its asset purchase program by £50 billion to £375 billion, and the People’s Bank of China cut both their one-year lending and deposit rates to 6.0% and 3.0% respectively.  Denmark and Kenya were also in on the act with reductions in interest rates.

The action comes in the midst of a noticeable mid-year slowdown in economic activity in many of the world’s major economies, which we mostly attribute to the prolonged confidence sapping European sovereign debt and banking crisis.  In fact the June quarter of this year is likely to mark the weakest point in global growth since the recovery from the GFC started.  In particular the slow-down in the euro zone is spreading to other countries in the area, although latest factory orders data out of Germany surprised on the upside.

The key question is the extent to which further monetary accommodation is in any way helpful.  We think not much.  Last weeks’ EU summit outcomes, although still short of a comprehensive solution, will prove to have had a greater positive impact on confidence than the ECB’s actions last night. 

As we have discussed before, the monetary policy transmission mechanism has broken down in Europe.  The answer to higher growth there lies in direct action to lower sovereign bond yields in countries under financial stress, an extension of time to meet agreed fiscal targets in countries contracting under the weight of harsh front-loaded austerity measures and further moves toward fiscal integration.  In the UK we believe last month’s “Funding for Lending” program will have a greater impact on the real economy than more quantitative easing.  Quantitative easing probably has its greatest impact on inflation expectations, not final demand.  It’s weak final demand that is currently the problem.

It’s in China where we believe easier monetary policy is likely to be more effective, although the surprise timing of the move has us worried now about next week’s second quarter GDP data.  The first easing last month preceded the release of a batch of weak economic activity data.  We think annual GDP growth will print at around 7.5%, down from 8.1% in March.  CPI data is also out next week.  It is falling inflation that is creating room for the PBoC to ease policy.  We continue to expect a modest recovery in the annual growth rate into the end of the year.