Europe vows to keep rates low
British and European central bankers break new ground to protect their economies from a U.S.-led surge in bond yields.
European central bankers broke new ground to protect their economies from a U.S.-led surge in bond yields, indicating they will keep benchmark interest rates low for longer than investors expected.
With rising market borrowing costs posing fresh threats to weak expansions, Bank of England Gov. Mark Carney and European Central Bank President Mario Draghi gave greater clarity over their monetary policy.
The pound and euro slid against the dollar, while bonds and stocks rose as both officials used rhetoric to distance themselves from Federal Reserve Chairman Ben S. Bernanke’s signal that the U.S. is preparing to start unwinding its $85-billion-a-month bond-buying program later this year. That had sparked a global sell-off in bonds, forcing up yields in economies less able than the U.S. to cope with tighter credit.
The European Central Bank and Bank of England “are declaring their monetary independence from the rising U.S. rate trend,” said Michael Saunders, chief Western Europe economist at Citigroup Inc. in London. “It’s the right thing to do because European economies need low rates.”
Carney, marking his debut at the helm of the Bank of England as the first foreign governor in its 319-year history, went first as the British central bank released a rare statement in which it said the recent increase in market rates “was not warranted by the recent developments in the domestic economy.”
Less than two hours later, Draghi told reporters in Frankfurt that the Europe- an Central Bank planned to keep its interest rates low or even lower for an “extended period” and that it was injecting a “downward bias in interest rates for the foreseeable future.”
The central banks turned to words over deeds as both kept their key interest rates at 0.5%, matching the median forecasts of economists surveyed by Bloomberg News. The Bank of England also left its bond-buying program unchanged at 375 billion pounds ($565 billion).
Thursday’s statements followed a rout in bond markets triggered by Bernanke on June 19. The 10-year British government bond yield rose to 2.59% on June 24, the highest since 2011. In the euro-area, Portugal’s 10-year yield climbed above 8% this week for the first time since November amid concern that austerity fatigue is taking its toll. Rates also rose in Italy and Spain, which have struggled to grow amid Europe’s debt crisis.
With short-term borrowing costs so low, central banks worldwide are increasingly adopting what economists call forward guidance to persuade investors they should restrain yields on bonds. That’s vital for the health of economies because those longer-term rates typically dictate the lending rates paid by governments, companies and homeowners.
“What the central banks today made very clear is perhaps the relation we saw in the past, where once the U.S. started to hike interest rates, that was closely followed by other central banks, maybe that is not the case this time around,” said Martin van Vliet, an economist at ING Bank in Amsterdam.
U.S. central bankers have nevertheless gone to great lengths to stress that a slowing of quantitative easing doesn’t spell an imminent end to low interest rates. Officials are talking about a “dialing back” rather than an exit, according to Fed Bank of Dallas President Richard Fisher.
“Recent central bank communication has had the look and feel of a globally coordinated action to pour cold water over financial market expectations of early rises in short-term interest rates,” said Nick Kounis of ABN Amro Bank in Amsterdam.
The clearer communications in Europe mark a new strategy from both central banks. The Bank of England has tended to release a statement only when changing policy, and several officials have questioned the potency of giving guidance. At the European Central Bank, Draghi and predecessor Jean-Claude Trichet routinely said they never pre-committed on policy decisions.
Thursday’s efforts are nevertheless softer than those adopted elsewhere. The Fed, for example, has previously set time frames for loose policy and went further in December by saying it wouldn’t raise its rates until specific inf lation and unemployment thresholds were breached. The Bank of Japan says it is focusing policy on achieving 2% inflation in two years.
The Bank of England is studying whether to pursue more formal guidance, and the analysis due for release next month will have “an important bearing” on August’s policy discussions, it said. The central bank will publish minutes of Thursday’s meeting July 17, showing how Carney and other officials voted on stimulus
Investors “believe that the statement is a down payment of a more substantive commitment to maintain low rates to be unveiled in August,” said Simon Ward, an economist at Henderson Global Investors in London.
Trevor Greetham, director of asset allocation at Fidelity Worldwide, said Britain is likely to echo the Fed by saying it will keep policy loose until unemployment falls to 6.5% so long as inf lation expectations remain tame. Still, some Bank of England officials, including chief economist Spencer Dale, have raised concern about signposting policy. Among the concerns is a risk to credibility if they had to renege on a commitment.
Draghi said the European Central Bank’s use of guidance was “unprecedented” and backed by all 23 members of the Governing Council after several forms were debated. It may have been a compromise after what he described as an “extensive discussion” about cutting interest rates. He said the bank kept an open mind on whether to drop the deposit rate below zero.
The European Central Bank hasn’t built formal frameworks or set specific economic targets for assessing the course of rates, according to an official familiar with its deliberations. Instead, officials will rely on the central bank’s traditional “two pillar” approach, a setup that looks at both money supply and a range of economic indicators, the person said.
Still, Tom Vosa, an economist at National Australia Bank in London, said that with Draghi saying monetary policy is expected to support activity into 2014, it may take until 2015 for the European Central Bank to tighten.