Bumpy road to recovery
Sheldon Slabbert on central banks
Central banks will be back in focus in the month ahead, with both the Australian and New Zealand central banks meeting this week followed by the Federal Reserve in the US and Bank of Japan, both on June 16.
These institutions are very influential in financial markets, and their policies have far-reaching effects. They are responsible for price stability, promoting sustainable economic growth and supporting employment. They also influence the amount of money in supply along with the rate of interest from which most types of debts like mortgages are derived and also the interest paid on savings accounts.
Central banks have traditionally operated in the background, but that changed when the meltdown in US real estate triggered the global financial crisis. Since 2008, central banks have been more actively intervening in markets, applying radical emergency measures to prop up asset prices while driving interest rates lower, in an attempt to get the global economy back on a path of sustainable growth.
This approach worked for some years following the financial crisis, but many now see that these emergency policies have reached the end of their usefulness and have become counterproductive, increasing the volatility in financial markets.
Ultra-low rates have the potential danger of masking the true longer-term cost of loans, distorting asset prices and forcing investors and savers to take on more risk than they would normally do in an attempt to earn interest on their savings, which may result in losses. Easy monetary conditions can risk misallocation of capital, which poses a risk to the economy. The overcapacity in China stands out as an example.
Many market participants believe monetary conditions will remain easy and rates will stay very low for the foreseeable future. However, there are limitations to central banking and when one considers that we have had a 30-year cycle of falling interest rates and eight years of emergency measures, it should come as no surprise that we are seeing a possible change in direction by central banks.
The US was the first mover following the onset of the crisis and may now take the lead in the normalisation process too, with its central bank hinting at another rate hike following the hike in December.
At home, we have recently seen the kiwi dollar strengthen against the aussie. Much of that can be attributed to the divergence in monetary policy between the respective Reserve Banks and the expected widening of the difference in interest rates between the two countries. Australia may cut further from an already low 1.75 per cent versus 2.25 per cent overnight rate in New Zealand.
The Australians are currently running a budget deficit while still managing the fallout from the collapse in mining and the recent cooling of the real estate market, which has many nervous of a US-style market collapse.
This has placed the Reserve Bank of Australia on the back foot and more likely to cut rates and maintain easy measures to help manage the economy.
Our domestic picture is looking more robust with strong migration numbers, stabilising dairy and a growing tourism sector. This may see our Reserve Bank keep rates on hold this week. The Reserve Bank of New Zealand may also be aware that inflation could pick up over coming months due to higher oil prices and a possible stronger US dollar, should the US follow through with its proposed interest rate hikes.
Central banks play an important role in the world economy and will be closely watched for changes in policies and for the potential start down the road to normalisation that may well be a bumpy one, but necessary.