The World Economy

Three central banks act in sign of alarm

China, the euro zone and Britain all loosened monetary policy in the space of less than an hour, signalling a growing level of alarm about the world economy

the Age,

6 July, 2012

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Of the three, the surprise move was from Beijing which lowered its lending rate by 31 basis points to 6 per cent following an interest rate cut just a month ago that also came out of the blue.

The European Central Bank cut rates to a record low 0.75 per cent following a dire run of economic data. But it steered clear of bolder moves such as reviving its government bond-buying programme or flooding banks with more long-term liquidity.

The Bank of England, whose rates are already at a record low 0.5 per cent, said it would restart its printing presses and buy 50 billion pounds ($US78 billion) of assets with newly created money to help the economy out of recession.

"It is a surprise that they are moving so quickly. It shows that policymakers' concerns about the global economy have only grown," Mark Williams, an economist at Capital Economics in London, said of the People's Bank of China's action.

A raft of Chinese data is due next week, including second-quarter gross domestic product that officials may know to be poor, he said. But they may also be trying to foster suggestions of acting in concert.

"Policymakers may have felt that cutting rates on the day that the ECB (did) the same would deliver a bigger impact, encouraging talk of a coordinated response to the slowdown in the global economy," Williams said. "Again, though, this might simply underline the seriousness of the downside risks."

'No coordination'

In Frankfurt, ECB President Mario Draghi denied any globally coordinated central bank action of the sort seen after the collapse of Lehman Brothers in 2008.

"On coordination, no, there wasn't any ... that went beyond the normal exchange of views on the state of the business cycle, on the state of the economy, and on the state of global demand," he told a news conference.

Asked if conditions were now as bad as they were in late 2008 when the world's financial system was teetering, Draghi replied: "Definitely not."

The action puts even more focus on what the U.S. Federal Reserve will do when it holds its next meeting on July 31 and Aug. 1. The Bank of Japan meets next week.

Last month, the Fed held off on another round of bond-buying but its chief, Ben Bernanke, said there was "considerable scope to do more" and Wall Street bond firms polled by Reuters saw a 50 per cent chance of another asset purchase programme.

Some encouraging data on the labor market on Thursday tempered anticipation the central bank could undertake a third round of bond purchases, known as quantitative easing or QE3.

But more weight will be given to Friday's nonfarm payrolls report, which is expected to show job growth picked up in June but still remained tepid at 90,000 jobs.

"If we get a couple of more bad jobs reports, (the Fed) will come in with more stimulus. Today's reports suggest they might hold off, but they will want to see more data before they decide," said John Canally, economist and investment strategist at LPL Financial in Boston.

In recent weeks, economic evidence from Asia, Europe and the United States has pointed to a world economy running out of steam.

Will it work?

All the major central banks, with interest rates at historic lows, face the law of diminishing returns.

The Bank of England had already created 325 billion pounds of new money before Thursday's addition. In doing so, it has successfully driven borrowing costs to all-time lows, yet the UK economy is languishing in recession.

"The BoE has been excessively optimistic about how powerful QE is," said Philip Rush, an economist at Nomura, referring to the money-creating strategies known as qualitative easing.

"The latest increase is more than just a token, but it is not hugely significant for the outlook for growth and inflation."

A poll conducted by Reuters found 27 out of 47 economists believe the central bank will stop at the announced 375 billion pounds in total. A minority said the BoE would do more, with a few still calling for as much as 500 billion.

The euro zone is no better off. "We see now a weakening basically of growth in the whole of the euro area, including the country or the countries that had not experienced that before," Draghi said.

Policymakers could counter that things would be much worse if they had not acted, but with most monetary policy levers already pulled, government action is also required to improve the world's fortunes.

The International Monetary Fund has urged the United States to quickly remove the uncertainty over the path of fiscal policy, which is set to tighten abruptly at the start of next year without congressional action.

Measures announced at a European summit last week bought some calm to the euro zone debt crisis with the promise of action to lower government borrowing costs, but economists say they did not tackle the root problems.

The ECB continues to put the onus on euro zone governments to solve their debt crisis and did not even discuss on Thursday "non-standard" measures such as buying Spanish and Italian bonds to lower borrowing costs which are not sustainable indefinitely.

Elsewhere, Denmark's central bank cut interest rates by 25 basis points, shadowing the ECB's action, in a historic move that put one of its secondary rates into negative territory for the first time. Kenya ended its nine-months-long hawkish stance with a bigger-than-expected 150 basis points rate cut.