Central Banks called into action – again according to Bank of Ireland’s Monthly Bulletin

Economic activity weakening
Prompting monetary policy easing

Markets have been expecting yet further central bank action across the major economies in response to poor economic data. Economic activity in the US remains relatively weak and employment growth has slowed. The UK is again in recession and the economy has been essentially flat now for eighteen months. The euro area economy managed to avoid a second consecutive quarter of negative growth in Q1 but GDP looks almost certain to have fallen again in the second quarter, according to Bank of Ireland’s Monthly Bulletin published today, 4 July 2012.

Author of the Bulletin, Michael Crowley, Senior Economist, Bank of Ireland said: “Given the extraordinary policy actions taken by central banks over the past number of years – including reductions in interest rates to historically low levels and large-scale quantitative easing and liquidity provision – the continuing poor performance of these economies raises questions about whether the policies have ‘worked’ and, moreover, whether further action will have any effect. The central banks’ answer to the first is, generally, that conditions would be much worse in the absence of these actions and, in the case of the Fed and the Bank of England at least, their answer to the second is that further action can support their economies.

“Hence the Fed has decided to extend ‘Operation Twist’ to the end of this year. It will buy a further $267bn of longer-dated government bonds, on top of the $400bn purchased since last September, which it says “should put downward pressure on longer term interest rates and help to make broader financial conditions more accommodative”. The Bank of England has indicated it will almost certainly announce a further round of ‘quantitative easing” at the July meeting, with additional government bond purchases of at least £50bn likely, on top of the £325bn purchased to date. It has already announced a new initiative – a ‘Funding for Lending’ scheme – jointly with the Treasury, whereby the latter will guarantee loans from the Bank to the banking sector at below market interest rates in an effort to boost credit growth.

“The ECB cut its main interest rate twice late last year, to 1%, though this is still above policy rates in the US (near 0%) and the UK (0.5%). It has also provided substantial liquidity to the banking sector, via two 3-year funding operations, which it says has helped avert a more serious credit contraction in the zone and which has had the effect of pushing short-term market interest rates well below 1%. While a further reduction in the policy rate may not have much impact on market rates, ‘a few’ ECB members still favoured a cut at the June meeting. President Draghi has also cited significantly increased downside risks to the economy. A rate reduction – probably 25bps – now seems likely in July,” concluded Michael Crowley.

Ends