Analysis: Global central banks will keep taking it easy

Central banks are in a deep easy-money hole of their own digging that they will have to start filling in at some point. But that day still looks quite some way off.

Indeed, the Bank of Japan and the Bank of England are staking out a much bolder stance, brushing aside warnings from some that they might be stoking currency wars by depreciating their currencies or sowing the seeds of asset bubbles and inflation.

For Japan, inflation would be a solution, not a problem, after years of gently falling prices. The country's nominal gross domestic product is no higher than it was 20 years ago, saddling the government with a debt-to-GDP ratio of 235 percent and climbing.

Britain seems simply to have concluded that higher inflation is a price worth paying to revive economic growth.

Three of the Bank of England's nine-member Monetary Policy Committee, including Governor Mervyn King, voted this month to buy more bonds under its quantitative easing (QE) program even though inflation has been above target for five years and is unlikely to fall back to its 2 percent goal for another three years.

"There are clear signs of a softening of the commitment to inflation control across a number of economies," said Simon Hayes, an economist at Barclays Capital in London.

A QUESTION OF JUDGMENT

Hayes said there was nothing wrong as such with banks buying bonds with newly minted money to breathe life into the economy.

The difficulty is to know when to start dialing down the stimulus when policymakers are uncertain, because of the damage wrought by the financial crisis, just what their economy's productive capacity is and how households and financial markets might react to the prospect of higher interest rates.

"QE in and of itself is not the problem; the problem is the general environment in which this is happening. It may well be that policymakers are inclined to err on the side of holding policy too loose for too long," he said.

Which is where the Federal Reserve comes in.

Stock markets around the world slumped on Wednesday after the latest minutes of the Federal Open Market Committee showed hawkish members of the U.S. central bank's policy-setting panel wanted to scale back or end QE before unemployment had fallen to the Fed's 6.5 percent target.

Many economists believe the markets over-reacted to the minutes, which give equal weight to the views of non-voting members of the 19-member committee as they do to those of heavyweight Chairman Ben Bernanke and his deputy, Janet Yellen.

Andrew Parlin of Kotell Advisors, an investment company in New York, is confident that the Fed chief knows monetary policy must remain highly accommodative until the economy is unquestionably on a firm footing.

After all, it was the premature withdrawal of monetary stimulus in 1932 that turned a recession into the Great Depression, on which Bernanke has published several academic articles.

As such, Parlin said he was not concerned about the FOMC minutes. "I think Bernanke and Yellen are totally on the same page, and they are firmly in control," he said.

TOO MUCH OF A GOOD THING

David Hale, who heads an eponymous global economics consultancy in Winnetka, Illinois, said the Fed was unlikely to start reducing asset purchases until well into 2014, not least because of fresh economic headwinds that are likely to limit first-half growth to 1 percent at most.

On top of an increase in the payroll tax that took effect on January 1, gasoline prices have risen sharply in recent weeks and across-the-board spending cuts due to kick in on March 1 could lead to 500,000 job losses in the second quarter.

"So I see no danger of policy changing in the short term. In fact there's a risk that the unemployment rate could increase," Hale said.

The Fed was more concerned that easy money was leading to excessive risk-taking as investors hunt for yield in a world of next-to-zero interest rates.

Bolivia, Latin America's poorest country, sold its first international bond in 90 years in October at a yield of under 5 percent. The $500 million issue was nine times oversubscribed.

Ukraine, rated well below investment grade, sold $1.25 billion worth of bonds the month after.

"These are very high-risk investments in great demand. That tells you we do have some mini-bubbles out there right now, but they're not in important sectors like housing," Hale said.

That's the problem with monetary policy. It's a blunt instrument. Central bankers worry that high-yield corners of the credit markets have risen too far too fast, but they are happy that investors are piling into conventional equities, reducing the cost of capital for companies.

Glenn Stevens, the governor of the Reserve Bank of Australia, noted with satisfaction on Friday that six rate cuts over the past 16 months totaling 1.75 percentage points were working their way through the economy.

House prices had been recovering since last May, and equities had risen significantly.

"The returns available to savers on safe assets - like bonds and bank deposits - have fallen by enough to prompt Australian savers to consider shifting their portfolios towards other assets. These are channels of monetary policy at work," Stevens told parliament in Canberra.

ALL EYES ON JAPAN

New Prime Minister Shinzo Abe hopes monetary policy will resume working as it should in Japan, which has been stuck in a twilight world of slow growth and mild deflation for most of the time since a housing and equities bubble burst at the start of the 1990s.

Abe has persuaded the Bank of Japan to harden its 1 percent inflation goal into a 2 percent inflation target and to switch to open-ended asset purchases starting next year.

But Abe, who will seek support for his expansionary policies when he meets U.S. President Barack Obama in Washington on Friday, is meeting resistance to his wish to name an aggressive successor to cautious Masaaki Shirakawa as BOJ governor.

Voices within the still influential financial bureaucracy, Abe's own party and the opposition, which will have a say in approving the candidate, worry that rapid money-printing could erode the appeal of government bonds and end the government's capacity to borrow at record low rates.

"It is important that the BOJ governor favors monetary policy easing, but we think that an extreme reflationist is not desirable," Seiji Maehara, a senior official with the opposition Democratic Party official, told Reuters this week.

What about the European Central Bank? Its key short-term interest rate, though a low 0.75 percent, is well above that of other major central banks, and few economists have expected it to cut.

But poor growth prospects might change the calculus. The European Commission forecast on Friday that the euro zone economy would shrink in 2013 for the second year in a row and unemployment in the 17-nation zone would reach a record 12.2 percent.

After Thursday's weak euro zone purchasing managers' index for February, economists at JP Morgan said a rate cut - though not the most powerful measure the ECB could implement - would help boost growth and head off pressures for the euro to rise.

"An exit from recession is still likely, but the journey looks to be slower and bumpier than we were expecting, and the improvement in economic activity looks to be disproportionately skewed towards Germany. We think recent developments are enough to prompt a policy response," they said in a note.

(Additional reporting by Tomasz Janowski in Tokyo; Editing by Will Waterman)