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Policy ponder: central banks head for the Portuguese hills

Published 06/23/2017, 08:52 PM
Updated 06/23/2017, 08:52 PM
© Reuters. FILE PHOTO: European Central Bank (ECB) President Mario Draghi arrives at the ECB Forum in Sintra in 2016

© Reuters. FILE PHOTO: European Central Bank (ECB) President Mario Draghi arrives at the ECB Forum in Sintra in 2016

By Hugh Lawson

LONDON (Reuters) - The cool shade of the hills above Lisbon will offer leading central bankers an escape from the summer heat in the coming week, but there is little they can do to get away from their differing monetary policy conundrums.

As the global financial crisis slowly fades from the rear-view mirror, the world's biggest central banks are struggling to decide how and when and what speed they can begin returning their monetary policy settings to something like normality.

The highlight of the European Central Bank's "Forum on Central Banking" in Sintra -- the old getaway of Portuguese monarchs -- is likely to be Wednesday's panel discussion including the heads of the European, British, Japanese and Canadian central banks.

For the ECB, the main issue over the next few months, after giving up its bias toward more rates cuts earlier this month, is whether to extend or start winding down its bond-buying program.

With euro zone growth picking up and inflation slowly moving in the right direction, as price data at the end of the week may show, the idea of extending the program will be anathema to the bank's more hawkish members, Germany in particular.

The 2.3 trillion euro program, designed to revive inflation, is set to run until the end of 2017, and a gradual withdrawal known as tapering would carry it well into next year.

On top of the economic arguments over whether to extend the program, there is a technical problem: the growing scarcity of German government bonds available for the ECB to buy.

Sources with direct knowledge of the discussion told Reuters this will be a key consideration for the bank when it discusses the bond-buying program.

Data from Germany's Ifo economic institute on Monday is expected to show only a slight fall in business morale this month from last month's record high, which may strengthen the resolve of those opposed to yet more money printing by the central bank.

"Our base case is that in September the ECB will announce a reduction of monthly purchases, starting in January 2018," Credit Suisse (SIX:CSGN) analysts said in a weekly note to investors.

BOE, BOJ, BOC

The Bank of England, meanwhile, is caught between rising inflation and a 30-year high in factory orders on the one hand and weak wages, political instability and the complex process of extricating the country from the European Union on the other.

The Bank voted 5-3 last week to keep borrowing costs unchanged - a closer outcome than expected - and on Wednesday its chief economist surprised investors by saying he was close to voting for a rate hike, too.

Part of the reason for the narrow split is inflation has hit its highest level in nearly four years, pushed up by the slump in the value of the pound since the Brexit vote.

Overall, analysts seem unconvinced that the Bank will vote in favor of increasing borrowing costs anytime soon.

"We find it hard to see why the BoE as a committee will risk a rate hike as the country heads into the Brexit negotiations in an environment of high political and economic instability," Credit Suisse wrote.

While the Bank of England and European Central Bank wrestle with their policy problems, however, spare a thought for the Bank of Japan and its bond-buying hangover.

After years of snapping up bonds in a bid to revive inflation, the BOJ holds assets equivalent to more than 90 percent of the country's gross domestic product.

And still inflation remains far below its 2 percent target rate, as a raft of data due out on Friday are expected to show.

Nevertheless, with the economy showing signs of recovery, talk is emerging about how the BOJ can begin preparing an exit strategy.

It faces a tricky balancing act: It must convince the markets it has a game plan, but if it reveals too much too quickly, investors could dump their bonds, sending yields sharply higher and destabilizing the market.

The Bank of Canada, meanwhile, shocked markets recently when it raised the prospect of hiking rates sooner than had previously been anticipated.

But data on Friday showed the country's inflation rate cooled more than expected in May, reducing the odds of an early rate rise.

So it too finds itself in the need of a bit of a Portuguese getaway.

© Reuters. FILE PHOTO: European Central Bank (ECB) President Mario Draghi arrives at the ECB Forum in Sintra in 2016

Latest comments

Lolol. Financial crisis just ahead not in the rear.
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