Prognosis negative from the ECB, the Fed and the RBA

We had a very interesting week so far. Interest rate decisions from few major central banks – Reserve Bank of Australia, FED and the ECB –Greece took euro zone to the gates of abyss and back and the start of the G20 meeting. Still, it is not over and we have to wait for the week-end most “interesting” decisions in recent history were taken during this time.
The RBA started the week by lowering the key policy rate by 25 basis points to 4.5%. For those not familiar with the Australian economy, this is an economy that has been doing very well since 2009 on the back of increased commodity prices and it actually had to raise key policy rate to control inflation. The RBA has a flexible inflation targeting regime. The importance of their decision on Tuesday this week is crucial as this economy is the first to feel global demand falling via commodity prices.
This is what the RBA said:
“Recent information is consistent with a moderation in the pace of global growth, though fears of a major downturn have not been borne out so far. The pace of US economic expansion picked up in the September quarter, but is still only moderate and leaves considerable spare capacity. China’s growth has slowed, as policymakers there had intended. Output in Asia has now recovered from the effects of the Japanese earthquake, and domestic demand in the region is generally expanding. Trade performance, however, is starting to see some effects of a significant slowing in economic activity in Europe, where the prospects are for economic weakness to continue. Commodity prices, while still at high levels, have generally declined over recent months.”
“After underlying inflation started to pick up in the first half of the year, recent information suggests the subdued demand conditions and the high exchange rate have contained inflation more recently, notwithstanding continuing sizeable increases in utilities charges. CPI inflation on a year-ended basis remains above the target, due to the effects of weather events last summer, but is now starting to decline as production of key crops recovers. Moreover, with labour market conditions now softer, …”
They do a very good job at capturing the global demand slowdown and implications for the domestic economy.
Then it was the Fed’s turn. With the Fed’s funds rate at zero there were no expectations about the key policy rate. We all wanted to know how the Fed sees the future. Unfortunately not bright. It also published its new forecasts for the US economy showing clear slowdown, albeit growing.
This is what the Fed said:
“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect a moderate pace of economic growth over coming quarters and consequently anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate further. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.”
The first sentence of this paragraph tells you that the Fed is not an inflation targeting central bank which allows it more leeway when it comes to decisions, i.e. flood the market with money, seen as inflationary by other central banks.
Finally it was the turn of the ECB to tell us their view. This was supposed to be a historical meeting as it was the first one presided by Mario Draghi the new ECB governor. And indeed it was. The ECB decided to surprise the markets and lower the key rate by 25 basis points to 1.25%. The surprise came from the fact that ECB is an inflation targeting central bank and current inflation in the euro zone is at 3%, 1% above the 2% target.
Here is what the ECB said:
“Real GDP growth in the euro area, which slowed in the second quarter of 2011 to 0.2% quarter on quarter, is expected to be very moderate in the second half of this year. There are signs that previously identified downside risks have been materialising, as reflected in unfavourable evidence from survey data. Looking forward, a number of factors seem to be dampening the underlying growth momentum in the euro area, including a moderation in the pace of global demand and unfavourable effects on overall financing conditions and on confidence resulting from ongoing tensions in a number of euro area sovereign debt markets…”
So far it has justified the decision to lower the key policy rate but nothing on the inflation. And here it is:
“Inflation rates have been at elevated levels since the end of last year, mainly driven by higher energy and other commodity prices. Looking ahead, they are likely to stay above 2% for some months to come, before falling below 2% in the course of 2012. Inflation rates are expected to remain in line with price stability over the policy-relevant horizon. This pattern reflects the expectation that, in an environment of weaker euro area and global growth, price, cost and wage pressures in the euro area should also moderate.
The Governing Council continues to view the risks to the medium-term outlook for price developments as broadly balanced, taking also into account today’s decision. On the upside, the main risks relate to the possibility of increases in indirect taxes and administered prices, owing to the need for fiscal consolidation in the coming years. In the current environment, however, inflationary pressure should abate. The main downside risks relate to the impact of weaker than expected growth in the euro area and globally. In fact, if sustained, sluggish economic growth has the potential to reduce medium-term inflationary pressure in the euro area.”
The ECB uses two main reasons for lowering the key rate while inflation is above target and will remain there for some time. First, it says that recent price developments were the result of supply shocks and thus monetary policy cannot really respond, at least to the first round effect. Second, it sees a rapid and aggressive slowdown in the euro zone economic growth which will abate any inflationary pressures.
Final remarks
Irrespective of their monetary policy regime all these major central banks took steps to relax their monetary conditions. But what is very interesting is that while current inflation is still present in all three their forward looking decisions show were their current concern lies: future economic growth. All three see global demand falling with major implications for all of those open economies. And of very much interest to me is the ECB’s decision. This will not be a decision that will bode well with the either German public or the Bundesbank. If there is one way to push Germany out of the euro zone then an inflationary ECB will do it for sure.
Coming back home, these decisions from the RBA, the ECB, and the FED should be very good lessons for Romania. Big, open and flexible economies are getting ready for the worse and are providing liquidity to their domestic market. In the previous crisis when those economies stalled Romania crashed. I do not believe that in the last three years we reformed enough to just stall with them so we need to do more to cushion the blow. More about Romania in a later post today or tomorrow.

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One thought on “Prognosis negative from the ECB, the Fed and the RBA

  1. The australian decision and view is the only one of interest for me.🙂.

    I’m on the side considering that ECB should have never increased the rate, and it should bring it to 1% or even much lower. But they seam to care more about Germany than about the euro area🙂. May be Draghi is giving a signal that he has a different view about monetary policy for the euro area.

    In the developed countries the inflation usually depends mostly on the basic material prices, such as oil or minerals, and not necessary on the demand. This is true even in normal times in the past. For instance, 2007, and 1999,mostly, were both high inflationary years for all the countries, and last year of growth, from there it started the decline. In those years the oil demand surpassed a lot the supply, and the price of oil had a spike up. And not only oil. I wouldn’t see it as a coincidence.

    Even nowadays, this q and the last one, I’ve listened for some CEOs at the earnings conferences complaining about the level of basic materials prices, and some in the basic materials field said their sells increased but this was because higher prices, the volume sold decreased compared to similar periods in 2010. And is the volume sold which tells us the true story.

    So, as the inflation has nothing to do with the demand, mostly during these times we are living, i can agree with FED and ECB in this one🙂.

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