Friday, April 11, 2014

When Doves Cry: monetary policy in the G3

A key theme for us this year was that despite the improved global growth outlook, monetary conditions in the key developed economies would remain highly stimulatory and in two cases – the Euro area and Japan – possibly become easier.  Recent statements from the G3 central banks have not altered that view.

After the March Federal Open Market Committee (FOMC) meeting increases in interest rate projections (the dots in the central tendency projections) along with Chair Janet Yellen’s apparent definition of "considerable time" as six-months in the post-meeting press conference left markets concerned, overly in our view, that interest rate increases were closer than appeared likely before the meeting.

The release this week of the minutes from the March meeting should have left markets in no doubt as to the continued dovish bias of the Committee.  That followed an equally dovish speech from Yellen last week that, along with the minutes, consigns “dot-gate” and “six-months” to history as communication wobbles.

While the weather cops most (though not all) of the flak for the recent weakness in activity data, there was an interesting and important discussion about the degree of slack in the labour market. "Several" members of the committee thought there might be more slack in the labour market than suggested by the unemployment rate alone while “a couple” saw slack as more limited.

The weight of opinion in that discussion is consistent with Yellen’s speech last week in which she observed that the economy and the job market are not back to normal health and that the US economy needs extraordinary support for some time.  The discussion is not suggestive of a committee that is going to be in a rush to remove monetary accommodation.  That said the focus on the labour market reinforces for me that wages, more precisely unit labour costs, holds the key to the Fed’s next move.

The Euro zone economy is at a fascinating stage.  Growth is clearly better, but remains insufficiently robust to make any significant dent in spare capacity.  The complicating factor for the ECB is that the amount of spare capacity differs across the region, most notably between Germany where the output gap is small and closing and in the likes of Spain Italy and France where output gaps remain large.  On balance, risks to inflation remain to the downside.


The ECB left conditions unchanged at their meeting last week but clearly maintained an easing bias which was, if anything, reinforced by the comment that the Governing Council  is "unanimous in its commitment to also use the unconventional methods within its mandate in order to cope effectively with risks of a too prolonged period of low inflation".

All options remain on the table for the ECB including quantitative easing (QE).  Bank President Mario Draghi said the discussion was continuing around QE including determining which of private and public purchases would be most effective.

Just as there is a high hurdle for altering tapering in the US, there is a high hurdle to its introduction in the Euro zone and I'm not convinced the ECB is fully there yet.  But it can’t be ruled out either with high unemployment, continued corporate deleveraging and the risk of lower inflation.

The Japanese economy is also at a critical stage.  The Bank of Japan (BoJ) also left conditions unchanged this week but at the post meeting press conference Governor Haruhiko Kuroda acknowledged there was room for further easing, although he also said there is room to adjust conditions in the opposite direction i.e tighten.

While the BoJ was somewhat more cautious about the economic outlook this month, perhaps in response to the weaker than expected Tankan survey, I think they are being a tad optimistic about how well the economy will come through the April 1st consumption tax increase.

As discussed in the post below I think Japan is in for a period of low growth which along with the waning impact of the recent currency depreciation will see inflation turn down again in the months ahead.  That will force the BoJ’s hand if they remain committed to their 2% inflation target.