OBR on fiscal outlook - lots in here

INTERVIEW

Spending watchdog sees warning lights flashing

Sir Charlie Bean’s time in Threadneedle Street gives him rare insight into Britain’s economy

Charlie Bean spent 14 years at the Bank of England ending up as a deputy governor

MATT LLOYD FOR THE TIMES

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Sir Charlie Bean, board member at the Office for Budget Responsibility and former deputy governor of the Bank of England, is a rare creature among economists in public life. At 67, with a stellar career behind him and still playing a key role as arbiter of what the government can afford at its spending watchdog, he’s not afraid to speak frankly.

“With my OBR hat on, I am not allowed to say anything about the appropriate fiscal course of action,” he says when I ask which taxes Rishi Sunak should raise. “We crank the numbers, we don’t say what the chancellor should do.” But, of course, he does have an opinion, which he is happy to share.

“If you have to raise taxes, it makes more sense to raise them on things that are bad, which is the argument for sin taxes,” he says. “A tax on things that create global warming produces better economic outcomes as well as raising revenue. So one can certainly see the attractions of doing that.” It’s pretty clear that a carbon tax would be on Sir Charlie’s list of proposals to the Treasury if he was allowed to submit one.

We are talking taxes because the OBR forecasts at last month’s spending review left the chancellor little option. Its outlook was full of superlatives, just the wrong kind: the deepest recession since 1709, a contraction of 11.3 per cent; record peacetime borrowing of £394 billion; the highest level of national debt in 60 years at over 100 per cent of GDP.

Sir Charlie is in no doubt that “it was the right thing to do to let borrowing take up the slack” this year. The difficult bit is what comes next. “The financial crisis and now the coronavirus crisis are like wars in the sense that they are both justifications for temporarily higher deficits,” he says. “But it will obviously make sense once the crisis [has] passed to get back to normal settings to build up space for the next shock. Given we’ve had two bad shocks in the space of a little over ten years, I don’t think one should count on there not being further ones.”

Again he veers towards giving the chancellor advice. “One shouldn’t be content with simply stabilising debt-to-GDP,” he says. “If that was all you did during peacetime, when you have a succession of bad shocks the debt-to-GDP ratio just keeps on ratcheting up. So it does seem sensible to have a more ambitious target of gradually bringing it down.”

It is this observation that brings us on to tax because, as the chancellor said at his spending review, “underlying debt is forecast to continue rising every year” of this parliament, which he described as “clearly unsustainable”. Recent experience has been exactly what Sir Charlie fears. Since the financial crisis hit in 2008, debt has ratcheted up every year bar three, rising from 34 per cent to 85 per cent of GDP last year despite austerity, before leaping once more to 105 per cent, near levels for which Treasury officials would once reprove Italy.

The OBR’s forecasts suggest taxes will need to rise by roughly £30 billion just to stabilise the debt even after the £10 billion of spending cuts Mr Sunak unveiled last month that push the government up against the limits of its promise to “end austerity”. Sir Charlie’s recommendation suggests that £30 billion won’t be enough.

For him, the question is not whether debt should be falling but how fast to bring it down. That “depends upon your assessment of the likelihood of future shocks and things like the level of interest rates relative to growth”.

R

ight now, rates are low but that does not give Sir Charlie comfort. Inflation is a real risk, he says, only manageable if it is driven by an upward shift in the underlying growth rate. But “that’s the holy grail” of better productivity, which has eluded Britain for a decade. More likely is a spike in inflation during a cyclical rebound from the crisis, in which case the Bank of England would have to raise rates.

“Policy is highly stimulative at the moment,” he says warily, in reference to the £450 billion of quantitative easing this year and government spending spree planned for next year. A 1 per cent rise in both interest rates and the cost of government borrowing would add £17 billion to debt servicing. Inflation of 3 per cent would add another £6 billion. Paying for that small increase in debt servicing would mean 4p on income tax.

Sir Charlie expects the Bank, where he spent 14 years as chief economist and deputy governor, to keep rates low next year to drive the recovery but he supports proposals to start selling off the £875 billion QE portfolio soon. This year’s £450 billion of QE was “much more of a financial stability operation” than “conventional monetary policy to boost aggregate demand”. The Bank was acting as “market maker of last resort”, not trying to get people spending. “You’d be crazy to try to get more people to go to shops when the consequence is you get more infections,” he says.

As such, the intervention was similar to the £10 billion of corporate bond purchases done alongside QE in 2009. “As soon as the market came back, we sold those off,” he recalls. “That helps to realise that it would make sense to start unwinding QE before Bank rate got back up.” The unwind could begin next year if the economy recovers quickly, he says.

He is “not a huge fan of negative rates”. They hammer bank profit margins, which “can be counterproductive both in reducing the supply of credit and producing financial stability risks”. He would take a different approach; to impose negative rates not on deposits, as is the conventional understanding, but on “the rate at which the Bank lends” to high street banks. Or to put it another way, “paying the lender to borrow . . . effectively providing a public subsidy [to commercial banks]”.

“There is nothing to stop the central bank from saying we’ll pay you 5 per cent a year to take this money from us provided you lend it out,” he says. As a subsidy, however, it would require Treasury approval.

One thing is certain. He does not want to go through another forecasting round like the last, with staff holed up at home during the second lockdown, interrogating Treasury officials over Zoom. “I’m not sure whether we could expect the staff to go quite as far next time. I think some would be pretty close to breaking point.”

Negative interest rates - helpful analysis

Hopefully you are developing stronger critical thinking skills; this should help.

Why Sweden calls its negative rate experiment a success

Sweden's Riksbank, the world's oldest central bank, was the first to take its main repurchase rate negative in early 2015, to fend off deflation.

Published by

20 Feb 2020

 
 

It is the biggest monetary policy experiment of modern times. One that has divided economists, central bankers and politicians. But now that Sweden has called a halt to its five-year trial with negative interest rates the serious work has begun on looking at whether it worked. 

Sweden’s Riksbank, the world’s oldest central bank, was the  first to take its main repurchase rate — at which commercial banks can both borrow or deposit money — negative in early 2015, to fend off deflation, only returning to zero in December. 

The  end of the Swedish experiment is being watched with intense fascination, not just by those central banks that still have negative rates such as the European Central Bank and Bank of Japan, but also by authorities and economists worldwide pondering how to respond to the next downturn with limited ammunition to stimulate the economy. 

For many, it is still too early to judge  whether negative rates have worked or caused lasting damage to the economy and finance sector. But, Jakob Carlsson, chief executive of the Swedish life insurer Lansforsakringar Liv, is in no doubt. He calls sub-zero rates “a mistake”, arguing that they force people to save more and spend less. “Sooner or later, we will have to pay the bill for this experiment of artificially created negative rates,” he says.

Eurozone banks say they have paid €25bn in negative rates to the ECB since it cut rates below zero in June 2014, eating into their already weak profits. Other areas of finance have also felt the strain — Dutch pension funds, only narrowly  avoided cutting payouts to pensioners last year after the government intervened to loosen rules.

“The ECB, the US Federal Reserve and the entire central bank community are watching very closely what is happening in Sweden, it is an interesting empirical example,” says Guntram Wolff, director of the Bruegel think-tank in Brussels. 

“The real question is whether a change in interest rates from negative to zero has an impact on inflation and economic growth.”

Negative rates turn the principles of finance on their head by forcing commercial banks to pay to store money at the central bank rather than earn interest on it. At the same time, some countries and companies have been paid to borrow. Most recently, some individuals across Europe have begun paying to deposit large sums of money in banks, while  mortgage borrowers in Denmark have received money from their house loans rather than having to pay interest. 

The idea behind the topsy-turvy policy is to encourage banks to lend more money instead of holding it at the central bank, thus stimulating the economy by also lowering financing costs for companies and households. Denmark, the eurozone, Japan and Switzerland still have negative rates but the evidence on whether they work — and with what side-effects — is still being collected. 

The ECB, which last year cut its deposit rate to a new low of minus 0.5 per cent, argues that without its actions the eurozone economy would today be almost 3 per cent smaller and have 2m fewer jobs. “Clearly everybody is going to look at what conclusions are drawn from that monetary policy reversal . . .
in Sweden, but I wouldn’t draw any conclusions as far as our policies are concerned,”  Christine Lagarde, president of the ECB, said in February. 

Ms Lagarde has, however, promised to study the  side-effects of negative rates, as part of a strategic review of monetary policy. “The longer our accommodative measures remain in place, the greater the risk that side-effects will become more pronounced,” she told the European Parliament. 

Negative rates

A brief history of extreme monetary policy

Jun 2014

The European Central Bank cuts its deposit rate below zero for the first time to -0.1 per cent

Jan 2015

The Swiss National Bank cuts its deposit rate into negative territory for the first time to -0.75 per cent

Feb 2015

The Riksbank becomes first central bank to cut its repo rate below zero while Danish deposit rates hit a world-record low of -0.75 per cent

Jan 2016

Japan introduces a negative interest rate for the first time of -0.1 per cent

Mar 2016

Norway cuts rates to a record low of 0.5 per cent, but never goes negative and starts hiking again in 2018

Aug 2019

The total amount of negative yielding debt peaks at $17tn

Aug 2019

Denmark’s Jyske Bank offers a 10-year mortgage at -0.5 per cent but also imposes negative rates on some rich individuals’ deposits

Sep 2019

US president Donald Trump calls on the Federal Reserve to cut interest rates to zero or below to enable the country to refinance its debts more cheaply

Stefan Ingves, governor of the Riksbank, argues that negative rates have been a success in Sweden. But he accepts that had they continued indefinitely they could have had a detrimental impact, raising questions about their future value to policymakers. 

The Riksbank introduced sub-zero rates in 2015, not due to weak growth — gross domestic product increased that year by 4.4 per cent in the EU member state — but because of the risk of deflation. Inflation dipped briefly below zero in 2014 and only returned to the Riksbank’s 2 per cent target at the end of 2017 when Sweden’s repo rate stood at a record low of minus 0.5 per cent. 

“Inflation actually came back. So in that respect, going negative made the whole thing work,” Mr Ingves says, stressing that quantitative easing — government bond-buying — also helped. “The issue for us hasn’t been to stay negative for longer than we needed to”. 

The Riksbank has been here before. Its 2010-11 decision to raise interest rates after the financial crisis was closely scrutinised. On that occasion it reversed course and cut rates again soon afterwards, drawing charges of “ sadomonetarism” from Nobel-prize winning economists and inspiring the Fed to slow its monetary tightening. 

Now, there are  questions being asked again after the Riksbank raised rates while the Swedish economy is slowing and inflation falling. Mr Ingves is clear that in a world wracked by economic uncertainty, “if the choice were to be at zero or slightly negative, to be at zero is a good place to be”. He argues that as Swedish growth has been stronger in recent years than the eurozone’s “it is not all that strange that we slightly distance ourselves from the eurozone”. 

Yet, some economists argue that the Riksbank may be forced to return to negative territory if the economy weakens or the sharp drop in inflation — the annual rate fell from 1.7 per cent to 1.2 per cent in January on the back of low energy prices — intensifies.

After five years of running a negative rates policy the Riksbank governor identifies several areas where, he believes, they could cause long-term problems. Top of the list is the banking system, where critics claim negative rates could weaken already struggling institutions, discouraging lending and prompting savers and companies to hoard cash. 

As a byproduct, Dietmar Schake, sales director of Burg-Wächter, says Germany’s largest safe manufacturer has benefited from a one-third increase in sales since the deposit rate at the ECB went below zero. “Customers prefer to keep their money at home rather than in their bank accounts, where negative interest rates are threatening,” he adds. 

Mr Ingves says Sweden’s banks have coped better than those in the eurozone because a lack of bad loans and lower costs mean their return on equity has stayed relatively high. But even here there is now relief. Johan Torgeby, chief executive of one of Sweden’s largest banks SEB, says lenders involved in fixed income “struggled for years” and calls the end of sub-zero rates “good news”. He adds: “We have never really understood what effect negative yields have on [boosting] consumption.”

He is not alone. One of the reasons the Riksbank gave for its decision to end negative rates was that the public struggled to understand the policy and thought it “strange”. 

Banks provide 80 per cent of loans to European companies and households, making them the main channel to transmit interest rate policy into the wider economy. The Association of German Banks said in a recent report that negative rates had cost eurozone lenders a total of €25bn since they were introduced. “This burden is depressing the profitability of the banks and will ultimately even constrain their lending capacity,” it warned. 

Much of the debate about negative rates hinges on the idea of a “reversal rate” below which lending activity by banks is subdued and starts to fall. 

Research published last year by Princeton University economists Markus Brunnermeier and Yann Koby found that many of the benefits of negative rates are front-loaded — such as gains in asset prices on bank balance sheets — while the corrosive side-effects last longer. 

Bank lending in the eurozone was, however, shrinking when the ECB first cut rates below zero in 2014 and has since rebounded. Household lending is up more than 12 per cent since negative rates started, while corporate lending has grown 3 per cent. The ECB has also taken action to soften the blow for the banking sector, including a “two-tier” deposit system that exempts some of the money it holds for banks from negative rates, while also offering them loans at sub-zero levels to stimulate lending. 

Among the big losers have been savers. With more than $13tn of bonds trading at negative yields, a growing number of pension funds, insurance companies, and banks are struggling to generate sufficient returns, raising doubts over some business models. 

Mr Ingves acknowledges that Swedish insurance companies are heavily exposed to stock markets, unlike many of their European rivals. While shares have gone up, that has been good news. “But if the stock market is down at some time in the future, then risks are going up, and that increases risk in the system as a whole,” he adds. 

Isabel Schnabel, a German economist who recently joined the ECB board, says that criticism of its monetary easing policies in her country “is all too often combined with claims and accusations that have no basis in fact”. While the average German saver is €500 out of pocket because of negative rates, Ms Schnabel says an average borrower is €2,000 better off and the overall gains outweigh the losses, with Berlin saving billions of euros on interest payments. 

Another risk from negative rates is that they inflate asset price bubbles, while also keeping alive  zombie companies  that without cheap money would collapse. In Sweden, the big concern has been the housing market, with Mr Ingves repeatedly issuing warnings about record levels of household debt. 

A series of measures to make mortgages harder to access have eased Swedish fears. The Riksbank recently changed its outlook on rates. Even when they were in negative territory, it always forecast future increases. But in December, it said rates would remain at zero for years until, in the words of Mr Ingves, “the fog lifts” and there is a clearer view of the  global economy. 

Gabriel Blir, an estate agent in central Stockholm, talks of the struggle he had to sell a flat bought near the peak of the market in 2016 for SKr4.5m. Two earlier attempts failed when bids went no higher than SKr4.2m but this month, after the Riksbank’s comments on rates, the flat was snapped up for SKr4.45m (€420,000). “When you hear that interest rates will stay low for years, it is a big safety net for buyers,” he says. 

Such anxieties feed into the larger debate over the efficacy of negative rates. “There is an increasing realisation that the negative side-effects of these policies are becoming more apparent . . . while the benefits in terms of raising inflation to central banks’ targets have not been achieved,” says Danae Kyriakopoulou, chief economist at central banking think-tank OMFIF. 

Policymakers at the ECB seem committed to sub-zero rates in their quest to lift inflation. “The overall macroeconomic effect of unconventional measures remains positive . . . there may be diminishing returns from negative rates, though we are not yet close to the reversal rate,” says Olli Rehn, head of Finland’s central bank and a member of the ECB governing council. “If needed, we have capacity to cut further.” 

Mr Ingves appears less sure of the use of negative rates in the future. He underscores that they could indeed go below zero in Sweden again if the economy deteriorates, but he stresses that in a sharp downturn additional policies would have to take more of the strain. 

“I think there actually is a lower bound for the policy rate,” he says, adding that he finds it difficult to envisage a rate of, say, minus 5 per cent. Instead he argues the central bank would have to use its balance sheet more. So too would the government, whose debt is forecast to fall to close to 30 per cent of GDP this year, low by European standards. 

His comments echo those of Ms Lagarde, who said in February: “Monetary policy cannot, and should not, be the only game in town”. 

Central bankers are closely monitoring how Sweden fares in its move to zero rates as the outlook for growth and inflation both there and in the rest of the world remains uncertain. 

“We look forward to a day when we can get out of negative rates,” says Philip Lane, chief economist of the ECB. “At some point, the comparison of benefits and costs is going to change . . . It is a lot easier to make that decision when inflation is closer to 2 per cent, as in Sweden, than when it is still too far away, as it is here [in the eurozone].”

This article was written by Martin Arnold and Richard Milne from The Financial Times and was legally licensed through the NewsCred publisher network. Please direct all licensing questions to legal@newscred.com.

Negative/low interest rates are not all good

Savers feel the bite of negative interest rates
Well-heeled Germans considering putting their savings in Berliner Volksbank now have cause to think again.

From the start of this month, anyone opening an account will not only earn no interest on any deposits above €100,000 (£87,000), they will also have to pay 0.5% a year for the privilege of having the bank look after their cash.

ECB president Mario Draghi as ‘Count Draghila’

Other banks are also reported to be considering introducing what have been dubbed strafzinsen (punishment rates), as the effects of the ultra-loose monetary policy run by the European Central Bank (ECB) — already causing ructions in the financial world — make an impact on consumers.

Falling savings rates have been an especially sensitive topic over the past few years in Germany, where people are often reluctant to buy shares and where home ownership, at about 50%, is close to the lowest in Europe.

On average, Germans hold more than 40% of their financial assets in the form of bank deposits, and the savings rate, at about 10%, is almost twice the average in the eurozone.

When ECB president Mario Draghi again cut interest rates last month, the tabloid Bild published a photomontage of the outgoing bank chief with fangs, dressed as a vampire.

“Count Draghila is sucking our accounts dry,” said the headline. “The horror for German savers goes on and on.”

According to Germany’s banking lobby, the ECB’s low-rates policy is costing its members €2.4bn a year — a financial burden they are keen to share. Yet the banks are aware that they will have to tread carefully to avoid provoking a backlash and driving away customers. Rather than imposing negative rates across the board, most appear likely to quietly increase fees and charges instead.

About 400 of Germany’s 1,300 banks and sparkassen (savings banks) have already done just that this year, according to Biallo, a financial portal.

Let's take a quick look at EU economic data again

When will the ECB ease monetary policy again?

Posted on January 24, 2019

Sometimes life catches up with you really fast and we have seen another example of this in the last 24 hours, so let;s get straight to it.

Analysts at Deutsche Bank say European Central Bank’s Mario Draghi indicated the possibility of a one-off interest rate hike at his last press conference. With his next appearance due on Thursday, the president may choose to feed or quell that speculation. ( Bloomberg)

I found this so extraordinary that I suggested on social media that Deutsche Bank may have a bad interest-rate position it wants to get rid of [ask me if you want to know what this means - JB]. After all at the last press conference we were told this and the emphasis is mine.

Based on our regular economic and monetary analyses, we decided to keep the key ECB interest rates unchanged. We continue to expect them to remain at their present levels at least through the summer of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.

Now Forward Guidance by central banks is regularly wrong but it is invariably due to a cut in interest-rates after promising a rise rather than an actual rise. The latter seems restricted to currency collapses. So let us move onto the economic situation which has been heading south for a while now as the declining money supply data we have been tracking has been followed by a weakening economic situation.

France

This morning brought more worrying news from the economy of France from the Markit PMI business survey. It started well with the manufacturing PMI rising to 51.2 but then there was this.

Flash France Services Activity Index at 47.5 in January (49.0 in December), 59-month low.

So firmly in contraction territory as we look for more detail.

Private sector firms in France reported a further
contraction in output during the opening month of
2019. The latest decline was the fastest for over four
years, even quicker than the fall in protest-hit
December. The strong service sector that had
supported a weak manufacturing sector in the
second half 2018 declined at a faster rate in January.
Meanwhile, manufacturers recovered to register
broadly-unchanged production.

These numbers added to the official survey released only yesterday.

In January 2019, the balances of industrialists’ opinion on overall and foreign demand in the last three months have recovered above their long-term average – they had significantly dropped over the past year.

They record a manufacturing bounce too, but the general direction of travel is the same as the number for foreign demand has fallen from 21.8 at the opening of 2018 to 3.6 now and the number for global demand has fallen from 21.7 to 1.0 over the same timescale.

Perhaps we get an idea of a possible drop from wholesale trade.

The composite indicator has fallen back by five points compared to November 2018. At 99, it has fallen below its long-term average (100) for the first time since January 2017.

But in spite of a small nudge higher in services the total picture for France looks rather poor as we note that it looks as though it saw a contraction in December and that may well have got worse this month.

Germany

There was little solace to be found in the Euro area’s largest economy.

“The Germany PMI broke its recent run of
successive falls in January thanks to a stronger
increase in service sector business activity, but the
growth performance signalled by the index was still
one of the worst over the past four years.
“Worryingly for the outlook, the recent soft patch in
demand continued into the New Year.”

So some growth but not very much and I note Markit are nervous about this as they do not offer a suggestion of what level of GDP ( Gross Domestic Product) grow is likely from this. This of course adds to the flatlining we seem to have seen for the second half of 2018 as around 0.2% growth in the fourth quarter merely offset the 0.2% contraction seen in the third quarter.

Also the recovery promised by some for the manufacturing sector does not seem to have materialised.

Manufacturing fell into contraction in January as
the sector’s order book situation continued to
worsen, showing the steepest decline in incoming
new work since 2012.

The driving force was this.

Weakness in the auto industry was once again widely reported, as was a slowdown in demand from China.

Euro area

The central message here followed that of the two biggest Euro area economies we have already looked at. The decline in the composite PMI suggests on ongoing quarterly GDP growth rate of 0.1%. Added to it was the suggestion that the future is a lot less than bright.

New orders for goods fell for a fourth successive
month, declining at a rate not seen since April
2013, while inflows of new business in the service
sector slipped into decline for the first time since
July 2013

Inflation

The target is just below 2% as an annual rate so we note this.

The euro area annual inflation rate was 1.6% in December 2018, down from 1.9% in November

Of course being central bankers they apparently need neither food nor energy so they like to focus on the inflation number without them which is either 1.1% or 1% depending exactly which bits you omit, But as you can see this is hardly the bedrock for an interest-rate rise which is reinforced by this from @fwred of Bank Pictet.

More bad news for the ECB. Our PMI price pressure gauge fell by the largest amount since mid-2011, to levels consistent with monetary easing along with activity indicators.

Comment

The situation has become increasingly awkward for Mario Draghi and the ECB as a slowing economy and lower inflation have been described by them as follows.

When you look at the economy, well, you still see the drivers of this recovery are still in place. Consumption continues to grow, basically supported by the increase in real disposable income, which, if I am not mistaken, is at the historical high since six years or something, and households’ wealth. Business investments continue to grow, residential investment, as I said in the IS [introductory statement] is robust. External demand has gone down but still grows.

Yet as we can see the reality is that economic growth looks like it has dropped from the around 0.7% of 2017 to more like 0.1% now. If we were not where we are with a deposit rate of -0.4% and monthly QE having only just ended they would be openly looking at an interest-rate cut or more QE.

Whilst we have been observing the slow down in the M1 money supply from just under 10% to 6.7% the ECB has lost itself in a world of “ongoing broad-based expansion”. It is not impossible we will see some liquidity easing today via a new TLTRO which would also help the Italian banks but we will have to see.

As to why there has been talk about an interest-rate rise well it is not for savers it is for the precious and the emphasis is mine.

As a result, reductions in
rates can end up having a similar effect as a flattening of the yield curve, as banks interest
revenue drops along with rates, but interest costs only adjust partially because of the zero
lower bound on retail deposits. In this situation, lowering rates below zero can pose a threat to banks’ profitability. ( ECB November 2018)

Extraordinary monetary policy development:

Swiss banking group UBS will start charging customers a negative interest rate of 0.6%. The measure will apply to customers with deposits worth one million euros or more.

 That's quite chunky, especially if you consider that positive interest rates (it still feels a bit weird that we have to clarify this now) haven't been at 0.6% for a while now.

 As a reason for imposing the charge, UBS names the "continuing extraordinarily low interest rates in the euro area" combined with "increased liquidity regulations". It's a direct consequence of steps by the European Central Bank asking private banks to pay a small percentage for storing their money with them instead of lending it out or investing it.

Extreme monetary policy

A bit heavy in places, but some useful charts, and short sections that you could use in evaluation:

Do Central Banks Help Or Hurt? Or Do They Even Matter?

By Michelle Jones on March 3, 2016 3:05 pm in Business

The world’s central banks have been as busy as beavers, anxiously looking for ways to trigger inflation and pulling out all the stops to do it. From quantitative easing to zero interest rates and even negative interest rates, policymakers are trying anything and almost everything to repair their nations’ economies.


But are all these actions actually doing anything at all or worse, damaging the very thing they’re supposed to help? Deutsche Bank analysts note that in many cases, as with the Bank of Japan’s recent negative interest rate policy (NIRP) adoption, what central banks do actually causes the opposite of what they wanted to happen. In others, it seems like their policies simply coincided with recovery in the areas they were trying to impact. So is there any point to what the world’s central banks do?


Deutsche Bank Chief Global Strategist Binky Chadha and team call this into question in their February report titled “When Central Bank Actions Have Larger And Opposite Reactions.” They note that some widely held views are that policymakers have run out of ammunition or that they’re just not doing enough to boost their respective economies.

Bank of Japan impacts stocks, yen

They point to several episodes in which central banks actually create more problems with their policies than what they solve. The most recent example of this is the Bank of Japan, which surprised the markets in January by adopting negative rates. As a result of this move, Japanese stocks rallied, and the yen fell, although briefly.


However, Japanese stocks then tumbled, while the yen “rallied hard,” with stocks falling far below where they were before and the yen soaring much higher than where it was before the bank’s move to a NIRP.

European central bank does more harm than good

The Deutsche Bank team also points to several examples in Europe, as the region’s central bank has been the most active over the last couple of years, instituting four major easing efforts. In June 2014, ECB first moved to negative interest rates, then just months later, it moved further into the negative with rates. In January 2015, the ECB kicked off a round of quantitative easing, and then in December, the central bank did both QE and more negative rates.


Chadha and team note that three of those four easing rounds saw a decline in inflation expectations, which was the bank’s main objective, as measured by the five-year breakeven inflation rate. One came with a pause, while the other two occurred right away. The only time inflation expectations climbed was in January 2015, although even then, inflation breakevens reversed after a short time.

Is QE better than negative interest rates?

The Deutsche Bank team also argues that quantitative easing may be just as bad as negative interest rates, saying that the rise in inflation following the QE round only happened to coincide with oil’s bounce.

Further, the three easings in which inflation fell also brought a tumble in European stocks, meaning that they actually hurt investors’ appetite for risk.

Again, the QE round was the only exception, but there was a series of data surprises already underway at the time, and because the data is reported with a lag, there’s no way the data surprises could have had anything to do with the QE round. Further, the fix was only temporary, and a reversal came.

Another big problem wrought by the European central bank’s move to negative rates in 2014 was the collapse in oil prices, they add, which was precipitated by “the sharpest rise in the trade-weighted US dollar on record over the next 9 months.”

Further, the DB team notes that high yield inflows peaked the same month as investors rotated into HG, and they ask rhetorically why monetary easing would “cause a flight up the credit spectrum.” One reason is that high-yield spreads widen as oil prices fall and because investors expected bond yields to and capital gains to fall, which caused them to move to longer durations.

They add that the ECB didn’t even boost lending because lending had already recovered after the middle of 2012 during the central bank’s “whatever it takes” pledge and now remain at levels where they were before the crisis.

Central banks take cues from each other

What’s perhaps even more troubling is that central banks watch carefully what others do and often follow suit. The U.S. Federal Reserve hasn’t said that negative interest rates are out of the question because they appear to be working in Europe, with the emphasis on “appear,” as the Deutsche Bank team pointed out that in reality, they aren’t working.
Further, the Fed’s round of QE was believed to be successful and also likely drove the recent policies set forth by the ECB and the BoJ. However, there’s little to no evidence that what the Fed did even made a difference.

“The various Fed initiatives all coincided with low points in the data surprise cycle which would have reversed anyway, without any discernable impact on the trajectory of the economic recovery,” Chadha and team wrote. “They also resulted in a large rotation from equities into bonds.”