Personnel changes point to looser policy - Capital Economics
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Personnel changes point to looser policy

Global Central Bank Watch
Written by Jennifer McKeown
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Recent news about a number of staff changes among the world’s central banks has supported our view that widespread policy loosening is to come. As the next ECB President, we suspect that Christine Lagarde will be a stronger advocate of further policy stimulus than any of the other candidates who were in the frame would have been. President Trump’s nominees for the two vacant seats on the Fed Board would both support his case for significant rate cuts. Meanwhile, sackings and resignations at the Turkish and Indian central banks seem to confirm that governments there are pulling strings to achieve the policy loosening that they desire.

  • Lagarde selection strengthens our conviction of ECB rate cuts and QE to come.
  • Trump’s nominations may be less influential, but lend policy a dovish tilt.
  • Next year’s change of guard at the Bank of England could be meaningful.

Recent news about a number of staff changes among the world’s central banks has supported our view that widespread policy loosening is to come. The most prominent announcement has been that IMF Managing Director Christine Lagarde will succeed Mario Draghi as ECB President when his term ends this October. Meanwhile, Donald Trump nominated Judy Shelton (a director of the European Bank for Reconstruction and Development) and Christopher Waller (Director of Research at the St Louis Fed) to fill the two vacant seats on the Fed Board. And Turkey’s central bank Governor, Murat Cetinkaya, was sacked by President Recep Tayyip Erdogan.

All three developments are dovish for the economies in question and are indicative of the more general shift towards monetary policy loosening around the world. Ms Lagarde has consistently supported QE; under her stewardship, the IMF called for ECB asset purchases at least six months before the Bank delivered them in 2015. And the IMF has also been an advocate of negative interest rates. While it previously seemed unlikely that the ECB’s next President would be as dovish as Mr Draghi, this is now almost certain to be the case.

President Trump’s threats to demote or fire Fed Chair Jerome Powell have come to nothing so far, but he is making efforts to engineer a dovish Reserve Board from the sidelines. Christopher Waller openly shares the preferences of St Louis Fed President, James Bullard, who voted to cut interest rates last month. And Judy Shelton is a Trump loyalist. Despite arguing during the Obama presidency that monetary policy was set too loose, she now claims that rates should be cut to support growth and “ensure full access to capital”.

Admittedly, Mr Trump’s previous two nominations (Stephen Moore and Herman Cain) ultimately withdrew when it became clear that they would not get the necessary Senate approval. The same might apply to Ms Shelton given her political bias, inconsistent views and ill-founded policy suggestions such as a return to the gold standard. But Christopher Waller is a credible candidate and a highly trained economist to whom the Senate seems unlikely to object.

As for the Central Bank of Turkey (CBRT), while no reason was officially cited for Cetinkaya’s removal, it is widely understood that it was over his refusal to cut interest rates. His replacement, Deputy Governor Murat Uysal, is reported to have argued for a rate cut at the last MPC meeting.

So the direction of change resulting from these appointments and proposals seems clear. But the extent to which they will affect policy is less certain. On the whole, individual perceptions and opinions are important. None of the world’s major central banks set policy according to mechanical formulae such as Taylor Rules. (And of the 20 central banks covered in this publication, only Denmark’s is constrained by a fixed exchange rate.) Instead, the committees that set interest rates rely on their own judgement of what is appropriate to achieve their target. And while that target typically relates to inflation, some central bankers also need to decide how much weight to give to dual or secondary objectives such as employment or financial stability.

The influence of committee members varies somewhat by institution. Table 1 attempts to illustrate this for 20 central banks, shading factors which make individuals more influential in red and those which point to a weaker influence in green. In cases where committees are small, the opinions of one member are more likely to be pivotal. If members’ votes are published, they will have more chance to influence financial markets and the wider policy debate. Finally, if the central bank has always tended to make decisions by consensus, committee members will have less power. But if there is a history of disperse views and open disagreement, committee members might be more able to shape policy. This rationale is outlined convincingly in the 2005 ECB Working Paper, “Communication and decision-making by central bank committees. Different strategies, same effectiveness?”

Table 1: Influence of Individuals at Central Banks

Sources: Central bank websites, Capital Economics

Interestingly, particular US Fed Board members appear to have a relatively weak influence on policy outcomes. The committee is quite large, with 12 members when full, and each has one equal vote. Decisions have tended to be made by reaching a consensus and two voices among 12 are unlikely to alter the state of play significantly. A July cut now seems a near certainty after comments at Mr Powell’s testimony this week, and we suspect that further cuts will come in December and March next year. But this forecast does not depend on who is chosen to fill the two vacant spots. If Trump gets his way, his candidates’ appointments will prompt speculation of more aggressive loosening, especially if their forecasts then turn out to be below the bottom end of previous “dot plots”. But we doubt that this will amount to much unless President Trump goes further by trying to remove Powell or other Board members and replace them with those likely to do his bidding.

ECB Governing Council members are even less influential as individuals. The Council is huge, with 25 members who each have an equal say. Votes don’t always take place at all and, when they do, the outcome is not disclosed. Changes to the euro-zone’s National Central Bank Presidents are likely to have very little impact on the path of policy.

However, a change in ECB President is a different matter. They have tended to have a big influence on policy, most recently in evidence when Mario Draghi came to power and quickly reversed the rate hikes overseen by Jean-Claude Trichet before launching quantitative easing. As a newcomer to monetary policy and a non-economist, Ms Lagarde might rely more heavily on the views of her colleagues and seek to lead policy less. Note, though, that her Chief Economist Phillip Lane, who holds a PhD in Economics from Harvard and was a professor at Dublin’s Trinity College, is also a known dove. In all, Lagarde’s appointment has strengthened our conviction that ECB interest rates will be cut and QE relaunched before year-end.

The Turkish situation is very different. There, individual central bankers have a relatively strong influence in theory given the smaller size of the committee. But it is increasingly clear that the opinion that matters is that of President Erdogan and anyone who differs will simply be removed. The CBRT meeting on 25th July will be particularly informative. We had already anticipated a 100bp cut in interest rates, but a larger reduction of 200-300bps would be a clear indication that the central bank is responding more to government pressure than anything else. Aggressive loosening would worsen Turkey’s inflation problem and also prompt a sharp decline in the lira. While short-term interest rates may fall further, long-term rates will remain high and growth prospects appear bleak. Note that a similar situation applies in India, where the theoretical power of central bankers has been seriously limited by the government attempting to control their decisions. Last month’s resignation of RBI deputy governor Viral Acharya – one of the most hawkish members of the MPC – added to evidence that the government is pulling strings to achieve the policy loosening that it desires.

Of the other central banks, the Bank of England springs out as an interesting one. Decisions there are less likely to be made by consensus than elsewhere and policymaking relies on a set of diverse views and votes, so personalities are important. Not only will Mark Carney be replaced next January, but Andy Haldane and Silvana Tenreyro’s terms will also come to an end. Markets will be alert to any news about their replacements and hanging on the words of those in contention.

Our assumption is that interest rates will need to be hiked next year as price pressures continue to build. If, for example, the relatively hawkish Andy Haldane were replaced by a dovish candidate, that prospect would be a little less likely. But a bigger influence over policy will be the Brexit process and possible change of government. Note, after all, that the Labour Party has mooted changing the Bank’s remit.

One final point of note is the increasing presence of women in top spots at central banks, which has come to the fore again with Christine Lagarde’s appointment. According to a recent paper by Masciandaro et al.[1], women tend to be tougher on inflation and more likely to raise interest rates than men. We aren’t sure about that, but diverse teams undoubtedly make better decisions. And if the stereotype holds true, those female multi-tasking skills will certainly come in handy as the need to boost inflation from a persistently weak pace has to be balanced against financial stability risks related to elevated asset prices.

Review of recent policy changes

Since our last Global Central Bank Watch, monetary policy has remained dovish on the whole. Of the 20 central banks covered in this publication, only the Norges Bank raised rates (by 25bps), while the Reserve Bank of Australia and the Central Bank of Russia both cut rates by 25bps. (See Chart 1.) Meanwhile, the People’s Bank of China pushed down overnight interbank rates to multi-year lows.

Chart 1: Changes in Benchmark Rates

Sources: Bloomberg, Capital Economics

In other developments, Fed Chair Jerome Powell signalled a July rate cut at his semi-annual testimony to Congress this week, when he mentioned that “uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the US economic outlook”. And last month, Mario Draghi clarified the ECB’s dovish intentions during a speech in Sintra. The key message was that the ECB is prepared to ease policy through a combination of stronger forward guidance, a reduction in the deposit rate and a resumption of the asset purchase programme if required.

What’s next?

Among the advanced economies, it is now all but certain that the Fed will lower interest rates at its July meeting. Markets are pricing in a reasonable chance of a 50bp reduction, but we think that 25bp will be all that’s delivered for now. (See our US Economics Update.) Further loosening will follow, though, and we have pencilled in 25bp rate cuts at the FOMC meetings in December and March.

In the euro-zone, given the disappointing economic data and plummeting inflation expectations, we have moved our forecast of a 10bp cut in the deposit rate forward from December to September this year. Recent communications and the nomination of Christine Lagarde have supported our previously extreme view that QE will resume around year-end. We suspect that President Draghi will announce the forthcoming purchases before he leaves in October, leaving his successor with a clear road map for the year ahead. (See our European Economics Focus.)

Elsewhere in Europe, we still think that rates will be hiked once more in Norway. But the Norges Bank will be going it alone and interest rates will be kept at current low levels in Switzerland, Sweden and the UK for the rest of this year. (See Table 2.) The Bank of England should get back to raising rates next year, though much will of course depend on the Brexit process. In contrast, we expect the SNB to reduce its deposit rate early in 2020 as it strives to counter renewed upward pressure on the franc.

Table 2: Summary of CE Forecasts for Policy Rate Changes by the end of 2019

Policy

Direction

Economies

   

Easing

US, Australia, New Zealand, Canada, China, India, Mexico, Turkey, Russia, South Korea, South Africa, Euro-zone, Brazil

   

No Change

UK, Japan, Sweden, Denmark, Switzerland, Poland

Tightening

Norway

   

Source: Capital Economics

Meanwhile, we think that interest rates have further to fall in Australia, New Zealand and Canada. (See Chart 2.) Indeed, in Canada, we expect muted GDP growth this year to prompt the Bank to cut interest rates three times, starting in October.

Moving on to EMs, the recent stabilisation in credit growth in China suggests that more policy support will be needed to stimulate the economy. So far, the PBOC has been able to loosen monetary conditions by stepping up the volume of its liquidity injections, while leaving the rates on its lending facilities unchanged. But it is reaching the limits of this approach and we think that it will reduce its 7-day reverse repo rate before long. We have pencilled in 75bps of cuts by early next year, which is more loosening than markets anticipate.

Chart 2: Change to Policy Rates by End-19 Implied by OIS Markets & CE Forecasts (%)

Sources: Bloomberg, Capital Economics

In India, we have pencilled in another 25bp cut in this cycle, most likely at the next meeting in August. However, the recent resignation of one of the more hawkish members of the MPC has increased the likelihood of further cuts beyond August’s meeting, as well as raising fresh concerns about the RBI’s independence. Elsewhere, the dismissal of Turkey’s central bank governor has also raised the possibility of more aggressive rate cuts in the near term, which would make Turkey’s high inflation problem worse. We expect interest rates to be lowered by 800bp, to 16.00%, by early next year.

Finally, the strong support for Brazil’s pension reform bill in the lower house of Congress has reduced perceived risk and will support local markets. This gives the central bank more freedom to cut interest rates and we expect a 25bp reduction at the Copom meeting in July, followed by an additional 50bp of cuts over the following 12 months.

Table 3: Central Bank Policy Rates

Country

Policy rate

Latest

Last Change

Next Change

(CE Forecast)

End-2019

End-2020

End-2021

Major Advanced Economies

         

US

Fed funds target

2.25-2.50

Up 25bp (Dec. 2018)

Down 25bp (Jul. 2019)

1.75-2.00

1.50-1.75

1.50-1.75

Euro-zone

Deposit rate

-0.40

Down 10bp (Mar. 2016)

Down 25bp (Sep. 2019)

-0.50

-0.50

-0.50

Japan

Interest on excess reserves

-0.10

Down 10bp (Jan. 2016)

None on horizon

-0.10

-0.10

-0.10

UK*

Bank Rate

0.75

Up 25bp (Aug. 2018)

Up 25bp (H2 2020)

0.75

1.00

1.25

               

Other Advanced Economies

         

Canada

Overnight target rate

1.75

Up 25bp (Oct. 2018)

Down 25bp (Oct. 2019)

1.25

1.00

1.00

Australia

Cash rate

1.00

Down 25bp (Jul. 2019)

Down 25bp (Nov. 2019)

0.75

0.50

0.50

Switzerland

Sight deposit rate

-0.75

Down 50bp (Jan. 2015)

Down 25bp (H2 2020)

-0.75

-1.00

-1.00

Sweden

Repo rate

-0.25

Up 25bp (Dec. 2018)

None on horizon

-0.25

-0.25

-0.25

Denmark

Deposit rate

-0.65

Up 10bp (Jan. 2016)

Down 10bp (H1 2020)

-0.65

-0.75

-0.75

Norway

Sight deposit rate

1.25

Up 25bp (Jun. 2019)

Up 25bp (Sep. 2019)

1.50

1.50

1.75

New Zealand

Cash rate

1.50

Down 25bp (May 2019)

Down 25bp (Aug. 2019)

1.00

1.00

1.00

               

Major Emerging Economies

         

China

7-day reverse repo rate

2.55

Up 5bp (Mar. 2018)

Down 25bp (H2 2019)

2.05

1.80

2.25

India

Repo rate

5.75

Down 25bp (Jun. 2019)

Down 25bp (Aug. 2019)

5.50

5.75

6.00

Brazil

Selic rate

6.50

Down 25bp (Mar. 2018)

Down 25bp (Jul. 2019)

6.00

5.75

5.75

Russia

1-week repo rate

7.50

Down 25bp (Jun. 2018)

Down 25bp (Sep. 2019)

7.00

6.75

6.50

Mexico

Overnight target rate

8.25

Up 25bp (Dec. 2018)

Down 25bp (Sep. 2019)

7.50

6.50

6.00

South Korea

Base rate

1.75

Up 25bp (Nov. 2018)

Down 25bp (Jul. 2019)

1.50

1.25

1.50

Turkey

1-week repo rate

24.00

Up 625bp (Sep. 2018)

Down 250bp (Jul. 2019)

17.00

16.00

18.00

Poland

Reference rate

1.50

Down 50bp (Mar. 2015)

None on horizon

1.50

1.50

1.50

South Africa

Repo rate

6.75

Up 25bp (Nov. 2018)

Down 25bp (Jul. 2019)

6.50

6.25

6.25

               

Sources: Bloomberg, Capital Economics. *Based on a scenario in which Brexit is repeatedly delayed. For forecasts based on a deal or a no deal, see our UK Economics UpdatePick your own Brexit forecast”, 1st July 2019.

Table 4: Quantitative Easing & Other Unconventional Policies

Central bank

Monetary Base*

(% of GDP)

Planned Asset Purchases

CE Forecast of Future Changes

Federal Reserve Bank

16%

None on horizon.

The Fed announced at its March FOMC meeting that it will end the run-down of its balance sheet in September, and that it will cut the pace of its monthly redemptions of Treasury securities to $15bn from May. This would bring its balance sheet close to $3.6trn by September. At that point, the Fed will continue to roll off up to $20bn of MBS a month and will purchase offsetting amounts of Treasury securities. This means that once again the Fed will become a net buyer of Treasury securities.

European Central Bank

28%

None on horizon.

The monthly pace of net asset purchases fell from €30 billion to €15 billion in October. Since January 2019, there have been no further net purchases, but all asset holdings will be reinvested “for an extended period and for as long as necessary”. We think the ECB will relaunch QE for two years in November 2019, perhaps at a pace of €30 billion per month.

Bank of Japan

92%

Annual pace of ¥80trn.

While the Policy Board has reiterated that it will continue purchasing JGBs at an annual pace of ¥80 trillion, the actual pace of purchases has been well below that recently. With bond redemptions rising, we think that the annual net increase in JGB holdings will fall to around ¥25trn this year and ¥20trn in 2020.

Bank of England

26%

None on horizon.

The BoE has said that it will maintain assets at their current level of £445bn until Bank Rate has reached a level from which it can be “materially” cut. We suspect that this means around 2%, which is at least a couple of years away. If the UK leaves the EU without a Withdrawal Agreement, the Bank may restart its QE programme and Funding for Lending Scheme.

Swiss National Bank

82%

Occasional FX intervention.

The SNB will continue to intervene in the FX market if needed to prevent the franc from rising too far, particularly if policy loosening resumes in the euro-zone, as we expect.

Riksbank

11%

SEK 45bn of government bonds between July 2019 and December 2020.

The Riksbank announced at its April meeting that it will buy SEK 45bn of government bonds between July 2019 and December 2020. However, it will also stop reinvesting the principal and coupon payments from government bonds bought under its QE programme from July. Our view is that the balance sheet will not shrink significantly until at least 2023.

Sources: Central bank websites, Capital Economics. *Latest

Table 5: Calendar of Policy Decisions

Date

Economy

Policy Instrument

Prior

Survey

CE Forecast

18th July

South Korea

Base rate

1.75

1.75

1.50

18th July

South Africa

Repo rate

6.75

6.50

6.50

25th July

Turkey

1-week repo rate

24.00

24.00

25th July

Euro-zone

Deposit rate

-0.40

-0.4

26th July

Russia

1-week repo rate

7.50

7.40

7.50

30th July

Japan

Interest rate on excess reserves

-0.10

-0.10

31st July

United States

Fed Funds Target range

2.25-2.50

2.25-2.50

2.00-2.25

31st July

Brazil

Selic rate

6.50

6.25

1st August

United Kingdom

Bank rate

0.75

0.75

6th August

Australia

Cash rate

1.00

1.00

7th August

New Zealand

Cash rate

1.50

1.25

7th August

India

Repo rate

5.75

5.50

15th August

Norway

Sight deposit rate

1.25

1.25

15th August

Mexico

Overnight rate

8.25

8.25

30th August

South Korea

Base rate

1.50

3rd September

Australia

Cash rate

1.00

4th September

Canada

Overnight target rate

1.75

1.75

5th September

Sweden

Repo rate

-0.25

-0.25

6th September

Russia

1-week repo rate

7.50

11th September

Poland

Reference rate

1.50

1.50

12th September

Euro-zone

Deposit rate

-0.5

12th September

Turkey

1-week repo rate

24.00

18th September

United States

Fed Funds Target range

2.00-2.25

18th September

Brazil

Selic rate

6.25

19th September

Japan

Interest rate on excess reserves

-0.10

19th September

South Africa

Repo rate

6.50

19th September

United Kingdom

Bank rate

0.75

19th September

Norway

Sight deposit rate

1.50

19th September

Switzerland

Sight deposit rate

-0.75

-0.75

25th September

New Zealand

Cash rate

1.25

26th September

Mexico

Overnight rate

8.00

1st October

Australia

Cash rate

1.00

Sources: Bloomberg, Capital Economics

  1. “Do women matter in monetary policymaking?”, BAFFI CAREFIN Centre Research Paper (2018-88)


Jennifer McKeown, Head of Global Economics Service, +44 20 7811 3910, jennifer.mckeown@capitaleconomics.com

Yasemin Engin, Assistant Economist, +44 20 7808 4063, yasemin.engin@capitaleconomics.com

Written by
Yasemin Engin Assistant Economist
yasemin.engin@capitaleconomics.com +44 (0)20 7808 4063