BRUSSELS — Europe’s central banks are struggling with divergent quandaries over how to revive inflation and sustain economic growth as the US Federal Reserve prepares to start raising interest rates for the first time since the collapse of Lehman Brothers.
The world’s major economies are recovering at very varying paces from seven years of economic and financial crisis, with Japan tipping back into recession and China trying to surmount a severe wobble this year.
While the Fed is widely expected to pull the trigger on a slow but steady tightening from December in response to solid US growth and employment figures, the European Central Bank (ECB) is likely to ease monetary policy further on December 3.
“It (the ECB) cannot run the risk of disappointing markets, having raised expectations of action,” said Ken Wattret at BNP Paribas in London, reflecting the view of most economists polled by Reuters.
That is because headline inflation remains close to zero in the 19-nation eurozone, and core inflation stripped of energy prices and seasonal factors is barely 1%, just half the ECB’s target of close to but below 2%.
Meanwhile, the Bank of England (BoE) is still mulling when to make its first rate rise, and the Swiss and Swedish central banks are fretting over how to combat overvaluation of their currencies as the prospect of even lower ECB rates makes the euro cheap.
Central banks in the eurozone, Switzerland, Denmark and Sweden have already taken the rate they offer banks on deposits below zero, with the non-euro countries having to go deeper into negative territory to steady their exchange rates.
The policy dilemmas differ, but they have a common thread: it is increasingly hard for central banks to rekindle inflation in economies suffering from a long-term reduction in growth potential due to low investment, high unemployment and ageing populations.
Toolbox in question
ECB president Mario Draghi, who has signalled the bank will roll out more stimulus next week, strongly disputes suggestions that the central bank’s toolbox is exhausted. But others question how effective monetary policy can be when rates are at or near the so-called zero lower bound.
“Globally, interest rates have been extraordinarily low for an exceptionally long time, in nominal and inflation-adjusted terms, against any benchmark,” the Bank for International Settlements, the central bankers’ central bank, said in July.
“In some jurisdictions, monetary policy is already testing its outer limits, to the point of stretching the boundaries of the unthinkable,” the Bank for International Settlements said.
Central bankers are navigating in the dark because cheap ECB cash has muddied market interest rate signals and raised doubts about the reliability of traditional instruments for measuring inflation expectations.
No wonder the ECB is still exploring as many as 20 options for reviving inflation just eight days before its governing council’s rate-setting meeting.
Among those options are a further cut in the deposit rate of at least 10 basis points and possibly more, an increase in monthly purchases of government bonds and perhaps a two-tier deposit rate imposing a stiffer penalty on banks that park money with the ECB.
Monetary hawks such as German Bundesbank chief Jens Weidmann have refrained from publicly opposing further monetary easing, perhaps because German growth is slowing and Berlin’s key Asian export markets are weakening.
“You’ll never hear the Germans welcome a lower exchange rate but they are quietly satisfied,” a senior official of one eurozone central bank said, noting that the euro had shed 6% against the dollar since Mr Draghi flagged another easing.
Mr Weidmann did say last week that measures already taken needed more time to feed through to the economy, adding that the longer the ECB stayed with ultra-loose monetary policy, the greater the risks.
And Sabine Lautenschlaeger, the German member of the ECB’s core executive, flatly rejected any further money printing. ECB sources say she is often a dissenting minority voice.
Euro outsiders mull options
Outside the eurozone, BoE governor Mark Carney says he does not know when British interest rates could start to rise, sounding vaguer than before about when to start weaning the economy off record low borrowing costs.
“The question in my mind is when is the appropriate time for interest rates to increase, and that is strongly consistent with the strength of the domestic economy,” Mr Carney told members of parliament on Tuesday.
He also said pressure on the independence of central banks around the world had risen in recent years.
Governments, businesses and households have got used to an exceptionally low interest environment and many are resisting the turn of the tide, which could expose hidden weaknesses.
While Britain has its own monetary dynamics, Switzerland, Denmark and Sweden are highly dependent on ECB actions.
Under pressure from economists to do more to protect the Swiss economy from the effect of an overvalued Swiss franc, the Swiss National Bank’s (SNB’s) policy cupboard looks increasingly bare because even with negative deposit rates, the country remains a safe-haven refuge for foreign savings.
“The bad thing about today’s situation for the SNB is that they don’t have many tools left,” Credit Suisse economist Claude Maurer said.
Sweden and Denmark, which do not carry the same safe-haven burden, could always intervene in currency markets to prevent their exchange rates overshooting in case of further ECB easing, central bank watchers say.