Developments on the Chinese front have been mentioned by all the main central banks in their statements over the past week, and will continue to influence their decisions in the months ahead…..
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– The Bank of Japan and the ECB face no dilemma: heightened risks and a more uncertain global scenario impose ultra-accommodative monetary policies.
– On the other hand, the Fed, the Bank of Canada, and the Bank of England, face a dilemma because of domestic trends that call for a rate hike. However, the risk of the current monetary policy phase protracting are low, and advises central banks to stick to their existing monetary policy stance until the outlook becomes clearer.
– The Chinese crisis is significantly influencing the decisions of central banks, not only in the emerging economies, but in the advanced countries as well. A week ago, the European Central Bank explained its downward revision of growth estimates with the slowdown in the emerging economies, and showed openness to extending the EAPP if needed. As explained in this report, starting on page 2, next week the Federal Reserve could decide to postpone its reversal on rates, which as recently as a month ago seemed sure, due to the financial turbulences caused by the Chinese crisis. The influence of the situation in China was also mentioned by the Bank of England and the Bank of Canada in their remarks on their
monetary policy decisions (less critical, in the present phase, than the ones faced by the Fed).
– None of the countries mentioned is facing monetary policy dilemmas as dramatic as those of emerging countries impacted by the worsening of the terms of trade and by weaker demand for commodities, and which must also face the risk of a more burdensome servicing of foreign debt – and therefore have to stay on guard against contagion effects. For G-7 central banks, the impact stems from the slowdown in global demand and the tightening of financial conditions due to increased risk aversion (accompanied by a rise in credit risk premiums and a decline in stock indices), offset in part by the drop in medium and long term interest rates.
From this point of view, the Bank of Japan and the ECB face no dilemma. Japan is the G-7 country with the closest trade links with China (18.3% of exports); also, it tends to incur a tightening of financial conditions through the exchange rate (the yen appreciates in tense phases) and the stock markets. Therefore, the Bank of Japan is increasingly likely to decide to step up monetary accommodation in the near future. In the ECB’s case, trade links between
the euro area and China are much slacker, but within the context of a weakening recoverydue to international factors and to the total lack of inflation pressures, it is reasonable to seek to prevent an undesired deterioration of financial conditions.
– In other cases, a dilemma does exist due to the conflict between the domestic trend of the economy and the global scenario. The problem exists to differing degrees for the United Kingdom, the United States, and Canada, and for now implies a postponement of otherwise pressing restrictive monetary policy phases. Canada is feeling the negative consequences of low commodity prices; on the other hand, however, it is benefiting from a rather reactive exchange rate, from the positive trend of domestic demand, and from strong exports to the United States. If the situation in China stabilises, doubts will be cleared in a few months’ time, with the start of an upward interest rate cycle. The Bank of England had already set out on the path leading towards a bank rate increase between the end of 2015 and the beginning of 2016, complicated first by the Greek crisis, and then by the Chinese crisis. The latest minutes point out that downside risks to the growth scenario have increased, fuelling volatility.
However, as reported in the Monetary Policy Summary, “they must be weighed against the prospects for a continued healthy domestic expansion”, and “global developments do not as yet appear sufficient to alter materially the central outlook”, although they should be monitored. For the time being, only one Monetary Policy Committee member out of nine is in favour of an interest rate hike, but we think consensus will gel by the opening months of
2016, paving the way for a cautious monetary restriction cycle.
Appendix
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