Rate hikes will signal confidence in global growth

TIGHTENING policy by a notch only one day apart, the world’s top two central banks will hope to signal confidence in global economic growth, despite risks of a trade war, currency swings and political turbulence.

The US Federal Reserve is almost certain to raise rates again tomorrow, inching closer to a neutral policy stance, while the European Central Bank (ECB) is likely to signal on Thursday that its €2.55 trillion (R39.1trln) bond purchase scheme will end this year, a key move in dismantling crisis-era stimulus.

Although largely a coincidence, their twin steps suggest that the era of cheap central bank cash will soon be over. This indicates the major economies are strong enough to stand on their own, but also that central banks are keen to replenish their policy firepower before the next downturn.

For the ECB, the next step is likely to be another in a series of incremental moves, as policymakers seek to avoid any potential backtracking, mindful of their two disastrous rate hikes in 2011, which exacerbated the eurozone’s debt crisis.

The eurozone economy has been growing for more than five years, employment is at a record high, wage inflation is increasingly clear and bond purchases have done all they could to cut borrowing costs, making ending the scheme the logical next step.

The ECB has already said the €2.55trln asset purchase programme’s fate will be on the agenda on Thursday, but ECB President Mario Draghi must decide whether to declare the end or wait until policymakers next meet in July.

Tricky issue

The end of quantitative easing (QE) raises a tricky issue for the ECB: interest rate hikes are tied to the end of the purchases, with the bank’s guidance stipulating that rates will stay unchanged “well past” the programme’s conclusion.

With no purchases into 2019, more specific guidance will be needed to keep rate hike expectations anchored and to give the bank flexibility to delay if needed.

It is expected to opt for a formula that specifies steady rates for several quarters and for as long rates are consistent with its near 2 percent inflation target.

But with growth slowing and yields on the periphery rising because of fears of political instability in Italy, downside risks appear to be increasing, suggesting to some that the ECB may try to get out early to avoid being dragged into politics.

“For what it’s worth, the ECB has recently decided to look through political events,” UBS said in a note to clients. “Moreover, some countries may have an interest in reducing the support to a populist government. After all, the QE programme also entails buying Italian government bonds.”

Some even argued that the ECB may opt for a June decision, because it fears bond market turbulence later that would make a July move more difficult.

“Accelerating the end-date announcement due to fears of an even more clouded economic outlook later on, fuelled by policy uncertainty, would do little to enhance the ECB’s credibility,” Société Générale economist Anatoli Annenkov said.

For the Fed, raising rates by 25 basis points to a range of 1.75 percent to 2 percent appears an easy call.

The US central bank is meeting both of its objectives: its preferred inflation rate is at 2 percent and the economy is at full employment.

The question is whether its rate hike projections – three moves both this year and next year – move up and whether it expects to hit the so-called neutral interest rate quicker than earlier thought.

“The domestic risks facing the US economy are arguably tilted to the upside,” ABN Amro economist Bill Diviney said. “A significant amount of fiscal stimulus is coming on stream when the economy is by many measures close to full capacity and growing at an above-potential pace.” – Reuters