Monetary policy: the Big Four

Prospects for the global economic situation have worsened noticeably in recent months, as evidenced by the business climate index published by the Ifo Institute. The sentiment barometer has already fallen for the fourth time in succession, indicating that global economic momentum is flagging. The gloomy mood is hardly surprising given the many global uncertainties. The trade dispute that has been brewing between China and the US for some time now remains unresolved. Added to that, there are worries that US government officials are poised to open another front in the trade war. A report from the US Department of Commerce indicates that the introduction of punitive tariffs on vehicle imports from Europe could be up for consideration. Another factor that is currently weighing on global economic prospects is the uncertainty over the progress of the Brexit negotiations. With the UK parliament deeply divided and the scheduled exit date of 29 March looming ever closer, market participants are gravely concerned.

If a disorderly exit by the UK from the EU cannot be averted at the last minute, and if the trade conflict escalates further, the possibility of some economic regions sliding into recession cannot be ruled out. This raises the question of whether the world’s leading central banks (Fed / BoE / BoJ / ECB) have sufficient monetary policy ammunition to ward off an economic downturn. Due to its past rate hikes and the reduction in the central bank balance sheet, the Fed has given itself some freedom of manoeuvre for the next crisis.  By contrast, the BoJ does not have much leeway for a further easing of monetary policy in a crisis scenario. Fact is, the Japanese central bank’s balance sheet already stands at over 100%(!) of the country’s GDP. As for the BoE, we think it is conceivable that the bank will actively extend its bond purchasing programme again. The BoE’s balance sheet currently amounts to around 23% of gross domestic product – some way behind the ECB, with a current figure of about 40%. Seen in those terms, BoE officials would have some potential for catching up.

The ECB’s remaining monetary policy ammunition is gradually running out. Should the clouds on the economic horizon darken further over the next few weeks and months, the monetary authorities could adjust their forward guidance for key interest rates. However, this would probably be an admission that the return to monetary policy normality will be later in arriving. Other courses of action for relaxing overall monetary policy conditions would include: extension of APP reinvestment period / revival of APP purchases / injection of liquidity. An overview of the policy options remaining open to the ECB shows that the bank has exhausted its monetary policy ammunition in recent years. This is evidenced by the fact that the central bank chiefs are being increasingly forceful in urging various Eurozone countries to implement reforms.

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