Daily Insight – The monetary policy divide

by: Nick Kounis , Peter de Bruin

  • ECB’s Nowotny pours cold water over idea of a refi rate cut…
  • …despite below-target inflation, lackluster growth and strong euro
  • FOMC will almost certainly continue aggressive monetary stimulus at its meeting…
  • …but roles of the central banks will gradually reverse over time

Nowotny asserts that there is ‘no realistic prospect’ of a rate cut

Ewald Nowotny, the Governor of the Austrian central bank and an ECB Governing Council member, made some particularly blunt remarks about the outlook for monetary policy and on the euro exchange rate on Tuesday. According to the news wire Market News International, he said that he did not think that having a negative deposit rate was a ‘realistic perspective’. In addition, nor was there a ‘realistic perspective of lowering the main policy rate’. To top it all off, although the Governing Council ‘did not welcome’ the appreciation of the euro, it had not ‘reached a dimension requiring a response’. He added that in any case he ‘did not see any instruments (to) use against it’ and that policymakers would ‘have to live with it’. Mr. Nowotny’s comments led to a further rise in the euro against the dollar, as they highlighted the great monetary policy divide across the Atlantic, with the ECB apparently ready to lay down and accept low inflation and a weak recovery, and the Fed set to press on with aggressive monetary stimulus.

 Fed almost certainly to sustain aggressive stimulus

Indeed, the contrast with the US could not seem starker, with FOMC officials likely to continue to see the need to press firmly on the monetary policy accelerator at their meeting on Wednesday. This seems to be close to a certainty following September’s weaker-than-expected nonfarm payrolls report, the deterioration of the dataflow on the back of the government shutdown and the hostile debt ceiling debate. This means that the Fed will decide to sustain asset purchases of USD 85bn a month. Meanwhile, the statement that will be released after the meeting will be as usual scrutinized in order to see whether the committee judges that the government shutdown will have any lasting effects on the economy. In the event, while we do think that FOMC members will acknowledge the recent deterioration of the dataflow, we expect that members continue to think that economic activity expanded at a ‘moderate pace’. Even though the pace of economic growth is somewhat above what we have been seeing in the eurozone recently, Fed officials are not satisfied and would like to see a more convincing pace of economic expansion in order to push up the rate of job growth and bring down the unemployment rate more quickly.


131030 Daily

 ECB and the Fed could soon swap seats

Despite these developments, we think that the ECB and the Fed could soon be changing places in terms of shifting monetary policy stance. For starters, it is worth noting that while Mr. Nowotny is certainly the most ‘verbally liberal’ member of the Governing Council, he is far from representing its central tendency. Indeed, according to ECB President Mario Draghi the council is actively considering a range of measures to keep policy accommodative and a rate cut remains on the table. In addition, although the central bank does not take strong positions on the level of the euro, its monetary policy does take it into account in so far as it impacts the outlook for inflation. Given the weak recovery, and elevated levels of labour market slack, the rise in the euro – if sustained – represents just one more source of disinflationary pressure for the eurozone. Indeed, inflation is likely to fall further in coming months, and it is currently at just 1.1%, which is far away from the central bank’s price stability goal. So we think the ECB will act by strengthening its forward guidance, in the first instance. On the other hand, we think that the Fed will start to shift back towards lowering the pace of monetary stimulus once it becomes clear that the US economy is convincingly accelerating and shaking off the effects of fiscal consolidation and the government shutdown. We expect it to reduce the pace of its asset purchases at the March meeting before hiking in 2015Q1. This shift in monetary policy stances on either side of the Atlantic will likely bring down EUR/USD over time.