Global Daily – Central bank action needed

by: Nick Kounis , Maritza Cabezas

  • Sweden’s Riksbank cut its overnight borrowing rate by 15bp to -0.5%…
  • …amid intensifying turmoil across financial markets
  • Decisive central bank action is needed
  • We think that central banks have plenty of firepower left and will eventually deliver

 

 

 

 

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Sweden’s Riksbank cut its overnight borrowing rate by 15bp to -0.5%

Amid intensifying stress across financial markets, Sweden’s central bank, unexpectedly cut rates moving deeper into negative territory and says it could go further. The decision was to support confidence in achieving its 2% inflation target. This resulted in a temporary weakness of the Swedish krona. If this decision fails to push the Krona lower, then it is likely that the Riksbank will intervene in FX markets, particularly if the ECB steps up monetary policy easing as we expect.

 

Time for central banks to be decisive…

Risks to the global economic outlook are mounting amid tightening financial conditions and the slide in oil prices. Thursday was another ugly day on financial markets, with equities falling sharply. Although bond yields have also fallen, credit conditions look to be tightening further. This effect is compounded in the eurozone and Japan, economies with ultra-low inflation, by the strengthening of their currencies versus the dollar. With global growth already struggling what will break the gloom?

 

…plenty of firepower left

We think decisive central bank action is needed. One concern has been that central banks lack ammunition. The pessimistic case is that the world economy is up a creek without a paddle. We think central banks have plenty on financial firepower left. From putting prospective rate hikes on hold, to more deeply negative rates to increasing QE, there are still options.

 

Next central banks in line

The missing ingredient at this stage is conviction by policymakers. Chair Yellen again on Thursday in her testimony to the Senate Committee on Banking, reiterated her concerns about risks to the economy, signaling that tighter financial conditions were an issue that the Fed is watching. However, the Fed should communicate more decisively that rate hikes are ice until the clouds lift. At the same time, while the ECB and BoJ are heading towards more easing, it is unclear to investors that they really will ‘do whatever it takes’ to lift growth and inflation. For instance, while ECB President Mario Draghi has sounded decisive, his message has been partly clouded by more cautious communication by other Governing Council members. Combined the ECB’s disappointing package in December, this has created doubts about whether Mr Draghi will deliver. We think central banks will eventually deliver, with global reflation efforts likely to intensify. The risk is that damage to the outlook has been done in the meantime.