Monetary Policy Week in Review – Dec. 15, 2012: Two central banks cut, 12 on hold as inflationary risks subside

    Last week 15 central banks took monetary policy decisions, with two banks cutting rates (Sri Lanka and Pakistan), one bank raising rates (Serbia) and 12 banks (Russia, Indonesia, West African States, Mozambique, United States, Iceland, Namibia, Chile, Korea, Switzerland, the Philippines and Fiji) keeping policy rates unchanged.

    Year-to-date, policy rates have been cut 120 times by the 88 central banks  followed by Central Bank News compared with 30 rate rises, i.e. a ratio of 4-1, illustrating the continuing global trend of easier monetary policy.

    The main feature of global monetary policy last week was the Federal Reserve‘s unveiling of new tools to stimulate the sluggish U.S. economy and improve the labor market. 

    The Federal Reserve, which can’t cut its federal funds rate further from effectively zero, dropped its forward policy guidance linked to time and replaced it with more explicit targets for unemployment and inflation rates. It also greatly expanded its asset purchase program, continuing its reliance on quantitative easing to keep long-term interest rates low.  

    Instead of pledging to retain the federal funds rate at close to zero at least through mid-2015, the Fed will now keep the rate at 0-0.25 percent at least until the unemployment rate falls to 6.5 percent or below, or until it sees inflation exceeding 2.5 percent, half a percentage point above it’s target.

    Federal Reserve Chairman Ben Bernanke stressed that this change in language didn’t imply a change in expectations of how long the federal funds rate will remain at this “exceptionally low range.” The expectation is still mid-2015, but this expectation is now explicitly based on the Fed’s published economic forecasts.

    What the Federal Reserve really did last week was to link its official mandate of maximum employment and stable prices to more specific operational targets, continuing its policy of becoming more transparent so it can better manage market expectations.

    Underscoring its determination to get Americans back to work, the Fed also linked the monthly purchase of $45 billion of longer-term Treasuries, on top of $40 billion in monthly purchase of mortgage-backed securities, to the labor market.  

    The Fed did not provide any target dates for halting or changing its asset purchases but tied the program to the state of the labor market and its impact on financial markets. If quantitative easing is no longer having any stimulative effect – like in the United Kingdom right now – or the risks from the Fed’s growing balance sheet start to grow, asset purchases will be modified.

    Globally, there were two messages from central banks last week.

    First, inflation is still low and there are no signs of an acceleration. Low inflation gave Sri Lanka and Pakistan room to cut rates and stimulate growth.

    Second, the prospects for global economic growth next year are starting to improve, helped by the reduction in interest rates this year. 

    Both Chile and the Philippines said third quarter economic activity was above expectations and Indonesia is looking ahead to stronger growth in 2013 and higher commodity prices.

    But optimism over next year’s outlook is hardly universal, underlining the lack of synchronicity in the global economy. 

    Switzerland is feeling the impact of Europe’s economic contraction and expects lower fourth quarter growth while South Korea reported sluggish domestic demand and expects only a moderate improvement in the global economy next year. And although the Federal Reserve expects growth of up to 3 percent next year, that will not be enough to significantly reduce the unemployment rate.

LAST WEEK’S (WEEK 50) MONETARY POLICY DECISIONS:

NEXT WEEK (WEEK 51) monetary policy committees in 12 central banks are scheduled to meet, including Hungary, Sweden, Turkey, India, Georgia, Norway, Croatia, Taiwan, Czech Republic, Japan, Trinidad & Tobago and Colombia.

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