Central banks ponder their policy options – NAB

Research Team at NAB, suggests that facing sub-target inflation and (at best) modest rates of economic growth, central banks in the big advanced economies have kept their policy interest rates at very low levels and been wary of moving to “normalise” them at higher levels.

Key Quotes

“Central banks in Japan, the Euro-zone, Sweden, Denmark and Switzerland have even been running negative interest rates – in which commercial banks pay to deposit their reserve funds at the central bank rather than receiving interest to do so.

Central banks in the UK, Japan and the Euro-zone are also undertaking massive asset buying operations to keep long term interest rates down and boost liquidity. These purchases have contributed to historically low long term bond yields, with investors paying borrowers (usually governments, but also some corporates) to hold their assets.

While all central banks have been wary of lifting rates to more “normal” levels, there are important differences in the health of their economies. Among the big economies, the US economy has gone furthest toward achieving success in getting sustained economic growth and the unemployment rate down. While inflation is still well below the Fed’s 2% target, it is expected to hit it over the medium term.

Several Fed Governors want an immediate hike in interest rates, 3 voted for a rise at the September rate setting meeting and other non-voting officials want a small rate rise now to pre-empt problems down the track. We expect the Fed to lift rates by 25 bps in December, followed up by 2 more rises next year but for rates to stay very low by historical standards considering the reasonable state of the economy.

Other advanced economy central banks seem nowhere near as ready as the Fed to consider lifting rates. In the wake of the UK’s Brexit vote, the Bank of England eased policy and at its September meeting the central bank said that another small interest rate cut looked likely if the UK economy behaved as expected. In the event, the UK has fared better than initially feared and the markets seem unconvinced that another rate cut is coming but we still consider one likely. Both the European Central Bank and the Bank of Japan have big asset buying programmes. Recent media reports that the former could wind back its buying look premature and the latter has recently re-emphasised its plans to keep its policy aimed at getting inflation up to its target.”