ECB and BoJ buckle in for the long haul - AmpGFX

Greg Gibbs, Director at Amplifying Global FX Capital, suggests that the Central bankers are reluctant to come out and say it, but reading between the lines and their lack of action in the face of declining inflation outlooks this year, suggest that they see limited scope for further policy easing.

Key Quotes

“ECB president Draghi said no new measures (buying equities, helicopter money) were discussed. The Governing Council didn’t even discuss extending the current end-date of the QE purchase program beyond March next year, even though it is widely expected that they will. Draghi only offered glibly that the current policy settings are working in lowering borrowing costs and generating growth (weak to modest) in credit aggregates.  Meanwhile, it edged lower its inflation forecast next year from 1.3% to 1.2%y/y, leaving unchanged its 2018 forecast at 1.8%.

Similarly, the BoJ has made marginal changes in its policy since it cut its cash rate target 20bp to -0.1% on 29 January despite clearly falling actual and expected core inflation, more than 1.5% below its 2% target.  In the last week it has emphasized that it needs to look more closely at the costs of this policy in comparison to the benefits, highlighted the drawbacks of QQE with NIRP, leant on the idea that Japan has ‘adaptive’ rather than ‘forward-looking’ expectations formation to justify extending the horizon for achieving its inflation target to a now unspecified “as soon as possible”.

It appears that the current set of policy options have been pushed close to their limits.  Further expanding purchases of bonds is difficult when they already own a large share of outstandings and yields are already so low, below negative across a large share of the market. Cutting rates further when they are already negative risks further undermining financial institutions’ profits to the point where it might impair credit creation going forward and undermine confidence.

Alternative easing options such as helicopter money or FX intervention appear to be outside their legally allowable policy options and are too controversial at this stage to consider.

Central bankers appear to be tweaking their current policy settings to prepare for a sustainable period of implementation, acknowledging that the battle to generate higher inflation may take a lot longer.  But they are reluctant to push these policies harder or try new measures.

They are now crossing their fingers and hoping that current policy will do the job if given enough time.  They are putting faith in higher oil prices helping lift those adaptive inflation expectations next year.

Part of this acceptance that policy is near its limits is apparent in more vocal appeals by central bankers to governments to speed up structural reform and expand fiscal policy (in a politically-correct manner of course; i.e. in ways that are sustainable and productive).

Fiscal policy support is being implemented in China, Japan, UK, Canada and a few other countries.  However, political impediments and a lack of fiscal space are restricting overall fiscal expansion, particularly in the Eurozone.

This inertia in central bank policy is contributing to complicated and uncertain financial markets, especially FX markets.”