Further loosening to come, but to little effect - Capital Economics
Global Economics

Further loosening to come, but to little effect

Global Central Bank Watch
Written by Jennifer McKeown

Following a wholesale shift towards policy loosening over recent months, there is now a general sense in financial markets and the media that central banks around the world have hit the pause button. We see this as an oversimplification and expect further policy loosening in many economies, potentially even in the US. But the big point is that this will do little to boost growth or inflation.

  • While the Fed seems to have pressed pause, we wouldn’t rule out a December cut.
  • Policy will be loosened further in the euro-zone, Australia and several EMs.
  • But the impact will be modest, particularly in advanced economies.

Following a wholesale shift towards policy loosening over recent months, there is now a general sense in financial markets and the media that central banks around the world have hit the pause button. We see this as an oversimplification and expect further policy loosening in many economies, potentially even in the US. But the big point is that this will do little to boost growth or inflation.

The upward shift in financial markets’ interest rate expectations in recent weeks (see Chart 1) has been at least partly justified by communications from the banks themselves. Most notably, the US Fed has dropped the line that it will “act as appropriate to sustain the expansion”, stating instead that the current policy stance is “likely to remain appropriate”. Meanwhile, the news that ECB Governing Council members were strongly divided over its latest policy changes have implied that further loosening there is far from a done deal.

Chart 1: Expected Short-Term Rate At End-2020 (%)

Sources: Refinitiv, S&P

Perhaps the most interesting sign that the global easing cycle has come to an end has come from a less closely-watched economy. Having applied a negative policy rate since early 2015, Sweden’s Riksbank warned this month that the repo rate would “most probably be raised in December”. This did not reflect normal considerations about an economic recovery or growing inflationary pressures. (On the contrary, the outlook for growth and inflation have worsened if anything in Sweden.) Instead, the decision appeared to reflect a view that negative interest rates are doing little good and perhaps even harming the economy. That could be a harbinger of trouble for central banks that more recently implemented, or which are still considering, negative interest rates.

We have some sympathy for the view that negative interest rates are damaging. We explained in a recent Global Economics Focus that there are signs that banks’ profitability is suffering and households’ saving rates are rising in countries where negative official rates and bond yields prevail. And cuts below zero seem to have had little effect on credit growth or inflation expectations. In Japan’s case, we think that such concerns will prevent any further loosening, in contrast to the market view that another rate cut may be to come.

But we are not convinced that this is the end of the road for policy loosening more generally. It is worth noting that not all advanced economies are out of ammunition. We expect considerably more interest rate cuts than markets assume in Australia and Canada and see the former also making its first foray into quantitative easing. And while recent encouraging data from the US have made the Fed’s next decision a close call, it still has scope to do more. If we are right that the economy will continue to disappoint, a December cut cannot be ruled out. The Bank of England’s more dovish tone will probably also translate into a rate cut, assuming that Brexit uncertainty persists following the election.

Even those that are near their limits seem likely to eke out a bit more stimulus. Given that the ECB has only just resumed its asset purchases, it is clearly still in stimulatory mode rather than at a pause. And we suspect that it will do more still, cutting interest rates from -0.5% to -0.8% and upping the scale of its asset purchases next year. Meanwhile, we think that the Riksbank is likely to overcome its aversion to negative rates and reverse December’s rate hike as the economy weakens again. (See here.) What’s more, there is scope for significant further monetary policy loosening in emerging markets, where interest rates are higher and central banks seem prepared to use their ammunition. (See here.)

However, it is hard to imagine that interest rate cuts or quantitative easing will be very effective in advanced economies, where yields are already so low. Emerging markets also face some constraints, with the PBOC in particular struggling to generate any pick-up in credit growth as banks contend with rising defaults and regulatory pressures. In all, then, our relatively dovish view of the near-term outlook for monetary policy does not translate into a much more positive outlook for the world economy. We expect a further slowdown in the near term, led by advanced economies. And when the recovery comes, it will be slow and do little to boost inflation.

Review of recent policy changes

Since our last Global Central Bank Watch, monetary policy around the world has been loosened further. Of the 20 central banks covered in this publication, none have raised rates, while six have cut rates. (See Chart 2.) The latter include two 25bp cuts by the Fed, a 5bp cut in the Medium-term Lending Facility (MLF) by the People’s Bank of China, 25bps by the Reserve Bank of India, 50bps in Brazil, and 250bps in Turkey.

Chart 2: Changes in Benchmark Rates

Sources: Bloomberg, Capital Economics

In other developments, the leadership of the ECB changed hands at the beginning of November as Christine Lagarde took over from Mario Draghi. This brings to an end Mr Draghi’s eight-year term as President. Ms Lagarde, who is likely to pursue broadly similar policies to Mr Draghi, looks to have a fight on her hands: recent clashes on the Governing Council over September’s decision to re-start QE reveals the lack of consensus over the future path of monetary policy. Elsewhere, the Bank of Japan tweaked its forward guidance to clarify that interest rate cuts would be the preferred tool to ease policy, though Governor Kuroda had already said as much in previous interviews. And in the US, a slightly more hawkish tone to the statement accompanying the Fed’s October rate cut suggested it was trying to dissuade markets from pricing in further loosening.

What’s next?

We expect most of the world’s major central banks to lower interest rates between now and the end of next year. (See Table 1.) In the advanced economies, we think that the markets have been too quick to dismiss the possibility that the Fed will cut interest rates in December. (See here.) But, should this occur, we think it will be the final cut of this mid-cycle adjustment as looser financial conditions encourage a pick-up in economic growth later next year.

Table 1: Summary of CE Forecasts for Policy Rate
Net Changes by the End of 2020

Policy

Direction

Economies

Easing

UK, US, Australia, Canada, China, Mexico, South Korea, Euro-zone, Brazil, Switzerland, New Zealand, Denmark, Russia

No Change

Poland, Norway, South Africa, Sweden, Japan, Turkey

Tightening

India

Source: Capital Economics

In the euro-zone, we anticipate that growth and inflation will be below ECB forecasts for 2020. If so, then the Bank will loosen policy further next year, though no announcement is likely for some time. Instead, Ms Lagarde’s first priority is likely to be launching a strategic review, which we suspect will result in the bank changing its inflation target to 2%. (See here.) Ultimately, we expect around 30bps of rate cuts by the end of next year – taking the deposit rate down to -0.8% – and that the pace of asset purchases will rise from €20bn to €30bn per month.

Elsewhere in Europe, we expect that the return of deflation in Switzerland will spur on the SNB to loosen policy before long. Meanwhile, the Riksbank looks set to fulfil its pledge to raise rates out of negative territory in December. But, in our view, this move is premature and will make Sweden the only G10 country to raise rates in the second half of 2019. We suspect that the Bank will be forced to row back on this decision in 2020.

As expected, the Bank of England left rates on hold at 0.75% after its November meeting. Much still depends on the Brexit process, though rate cuts seem more likely than not. And while markets expect a rate cut by the Bank of Japan next year, we think that the bar for further easing is high. Indeed, we suspect that the output gap would have to turn negative for the Bank to cut interest rates. (See here.)

Chart 3: Change to Policy Rates by End-20 Implied by OIS Markets & CE Forecasts (%)

Sources: Bloomberg, Capital Economics

Further policy loosening is likely in both Australia and New Zealand, with the former probably about to implement its first QE programme and the latter on course for two further rate cuts next year. And in Canada, we think that markets are underestimating the chance of a rate cut in December, though this depends heavily on whether the US and China reach a meaningful trade deal. (See Chart 3.)

Moving on to EMs, China’s PBOC has begun to take a more proactive approach to push down borrowing costs. For the first time since its introduction in 2016, the PBOC cut the MLF – one of its main policy instruments – by 5bp. This should directly feed through to a lower Loan Prime Rate (LPR), which acts as the benchmark price for new bank loans. The move could mark the beginning of a series of rate cuts as the PBOC responds to declining credit growth and an increasingly poor economic outlook.

In India, the 135bps of rate cuts so far this year has raised price pressures – indeed, we think headline inflation probably exceeded the RBI’s target in October. (See our India Economics Update.) This won’t dissuade policymakers from further easing in December, but – unlike the markets – we think that rate hikes are likely next year as a result. Elsewhere, despite signs that the economy is slowing more sharply than anticipated, high inflation in Poland makes policy easing there seem unlikely. But the easing cycles in both Russia and Turkey look unfinished as relatively low rates of inflation in recent months leave space for further rate cuts.

Similarly, inflation is low in Brazil and is set to ease in Mexico. In September, Brazil saw inflation fall to one of the weakest rates since at least 1980, which makes a further 50bp cut in the Selic rate at December’s meeting almost certain. And while Mexican inflation levelled off at 3% in September, lower fuel prices should reduce price pressures in the coming months. This should allow policymakers to cut rates by 50bp before the end of 2019.

Table 2: 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

1.50-1.75

Down 25bp (Oct. 2019)

Down 25bp (Dec. 2019)

1.25-1.50

1.25-1.50

1.25-1.50

Euro-zone

Deposit rate

-0.50

Down 10bp (Sep. 2019)

Down 10bp (Mar. 2020)

-0.50

-0.80

-0.80

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)

Down 25bp (May 2020)

0.75

0.50

0.50

Other Advanced Economies

Canada

Overnight target rate

1.75

Up 25bp (Oct. 2018)

Down 25bp (Dec. 2019)

1.50

1.25

1.25

Australia

Cash rate

0.75

Down 25bp (Oct. 2019)

Down 25bp (Dec. 2019)

0.75

0.25

0.25

Switzerland

Sight deposit rate

-0.75

Down 50bp (Jan. 2015)

Down 25bp (Q1 2020)

-0.75

-1.00

-1.00

Sweden

Repo rate

-0.25

Up 25bp (Dec. 2018)

Up 25bp (Dec. 2019)

0.00

-0.25

-0.25

Denmark

Deposit rate

-0.75

Down 10bp (Sep. 2019)

Down 10bp (Mar. 2019)

-0.75

-1.05

-1.05

Norway

Sight deposit rate

1.50

Up 25bp (Sep. 2019)

None on horizon

1.50

1.50

1.50

New Zealand

Cash rate

1.00

Down 50bp (Aug. 2019)

Down 25bp (Feb. 2020)

1.00

0.50

0.50

Major Emerging Economies

China

7-day reverse repo rate

2.55

Up 5bp (Mar. 2018)

Down 25bp (Dec. 2019)

2.30

1.80

2.25

India

Repo rate

5.15

Down 25bp (Oct. 2019)

Down 25bp (Dec. 2019)

4.90

5.25

6.00

Brazil

Selic rate

5.00

Down 50bp (Oct. 2019)

Down 25bp (Dec. 2019)

4.50

4.50

4.50

Russia

1-week repo rate

6.50

Down 50bp (Oct. 2019)

Down 25bp (Dec. 2019)

6.25

6.00

6.00

Mexico

Overnight target rate

7.75

Down 25bp (Sep. 2019)

Down 25bp (Nov. 2019)

7.25

6.75

6.75

South Korea

Base rate

1.25

Down 25bp (Oct. 2019)

Down 25bp (Q1 2020)

1.25

1.00

1.50

Turkey

1-week repo rate

14.00

Down 250bps (Oct. 2019)

Down 100bp (Dec. 2019)

13.00

14.00

17.50

Poland

Reference rate

1.50

Down 50bp (Mar. 2015)

None on horizon

1.50

1.50

1.50

South Africa

Repo rate

6.50

Down 25bp (Jul. 2019)

None on horizon

6.50

6.50

6.50

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 3: Quantitative Easing & Other Unconventional Policies
Central bankMonetary Base*
(% of GDP)
Planned Asset PurchasesCE Forecast of Future Changes
Federal Reserve Bank15%None on horizon.The Fed ended the run-down of its balance sheet in August and will continue to roll off up to $20bn of MBS a month and purchase offsetting amounts of Treasury securities. This means that once again the Fed is a net buyer of Treasury securities. In addition, for the next six months or so, the Fed has committed to purchasing Treasury bills to try to prevent a repeat of the recent money market liquidity squeeze, though this is not QE.
European Central Bank26%Monthly pace of €20bn.The ECB relaunched its QE programme in September 2019 at a monthly pace of €20bn, which we expect to increase to €30bn from mid-2020. The programme is open-ended which suggests that the ECB is locked into QE for several years. The new round of purchases will be “by and large the same kind of assets” as those bought previously, implying that around 75% will be public sector and the rest private sector securities. There is a 33% limit on the share of a country’s bonds it can hold.
Bank of Japan92%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 below ¥20trn in 2020.
Bank of England26%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 Bank79%Occasional FX intervention.The SNB intervened in the FX market to weaken the franc in mid-2019 and will continue to intervene if needed to prevent the franc rising too far, particularly when QE resumes in the euro-zone.
Riksbank10%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 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 banks, Capital Economics. *Latest
Table 4: Calendar of Policy Decisions
DateEconomyPolicy InstrumentPriorSurveyCE Forecast
13th NovemberNew ZealandCash rate1.000.751.00
14th NovemberMexicoOvernight target rate7.757.507.50
21st NovemberSouth AfricaRepo rate6.506.50
29th NovemberSouth KoreaBase rate1.251.25
3rd DecemberAustraliaCash rate0.750.750.75
4th DecemberPolandReference rate1.501.50
4th DecemberCanadaOvernight target rate1.751.631.50
5th DecemberIndiaRepo rate5.154.90
11th DecemberUnited StatesFed Funds target range1.50-1.751.50-1.751.25-1.50
11th DecemberBrazilSelic rate5.004.50
12th DecemberEuro-zoneDeposit rate-0.50-0.50
12th DecemberSwitzerlandSight deposit rate-0.75-0.75
12th DecemberTurkey1-week repo rate16.5013.00
13th DecemberRussia1-week repo rate6.506.25
19th DecemberJapanInterest on excess reserves-0.10-0.10
19th DecemberSwedenRepo rate-0.250.00
19th DecemberNorwaySight deposit rate1.501.50
19th DecemberUnited KingdomBank rate0.750.75
19th DecemberMexicoOvernight target rate7.25
8th JanuaryPolandReference rate1.50
21st JanuaryJapanInterest on excess reserves-0.10
22nd JanuaryCanadaOvernight target rate1.501.25
23rd JanuaryEuro-zoneDeposit rate-0.50
23rd JanuaryNorwaySight deposit rate1.50
29th JanuaryUnited StatesFed Funds target range1.50-1.751.25-1.50
30th JanuaryUnited KingdomBank rate0.75
31st JanuarySouth AfricaRepo rate6.50
4th FebruaryAustraliaCash rate0.50
5th FebruaryPolandReference rate1.50
5th FebruaryBrazilSelic rate4.50
6th FebruaryIndiaRepo rate4.90
7th FebruaryRussia1-week repo rate6.00
12th FebruaryNew ZealandCash rate0.75
12th FebruarySwedenRepo rate0.00
Sources: Bloomberg, Capital Economics

Jennifer McKeown, Head of Global Economics Service, +44 20 7811 3910, jennifer.mckeown@capitaleconomics.com
Bethany Beckett, Assistant Economist, +44 20 7808 4052, bethany.beckett@capitaleconomics.com