The fact that Japan’s government and the central bank are fighting an uphill battle to get Japan’s economy moving has been well-known for decades. Nevertheless, the last two weeks have been interesting, as the latest meeting in the central bank’s monetary committee caused an unusual speculation in the financial markets.
Prior to the meeting, Bank of Japan (BOJ) directly intervened in the government bond market thrice to prevent the 10-year bond yield to exceed 0.10 pct. The outcome of the meeting may be to allow an increase to 0.20 pct., but in reality, BOJ has confirmed to continue the very extreme quantitative monetary until 2020. BOJ believes that monetary policy will one day create price inflation, which is not yet the case after five years of trial, and in my opinion, will never happen.
In China, both the government and the central bank are of course, completely on the barricades, due to the trade war with the United States. In a crisis situation, any country’s central bank will provide extra liquidity to the domestic economy to ensure that a shortage of liquidity doesn’t block economic growth. This is also the case in China, though at the same time, the renminbi (RMB) has dropped with almost 10 pct. since the beginning of April. The speculation is that the RMB might continue to lower, but I doubt. Should this happen, it will certainly intensify the U.S. – China trade conflict, but it may also affect the export from ASEAN countries to China.
Even India’s central bank, the Reserve Bank of India (RBI), is on the move, as it hiked the interest rate by 0.25 percentage points to 6.5 pct last August 1st. It was not particularly surprising, but a creditable and professional action.
The reason behind the action is that inflation has now reached 5 pct. Further does the RBI argue that the increased subsidies to the agricultural sector will create both direct inflation and second-round inflation. The rate action is linked to the minimum price guaranteed to farmers for certain crops, as the minimum prices have been raised by the government. It supports the farmers’ income so much, that households in the rural areas now get a higher disposal income, giving room for higher consumption. The result is a direct increase in food prices, but RBI estimates that the price increases will spread in the economy. The commendable action of the central bank is that in spite of a political control of the monetary committee, an interest rate hike has been forced through, in order to combat expected inflation. At the same time, the monetary policy becomes the natural counterweight to the government’s increased public spending – there are many Emerging Market countries that can learn from this, including the Philippines, though also western countries.
The question is whether a leading central bank like the European Central Bank (ECB) has the capacity to show the same courage and foresight? Based on the empiricism since the global financial crisis, the answer is no. The ECB is in fact, currently unable to conduct the same professionalism and strength, like for example, the central bank in India is.
My concern is that the financial market will one day react negatively to the European situation, and this development can emerge in several ways, where inflation is one risk. The inflation in the Eurozone is at present around 2 pct., though we all expect the inflation to fall again, due to lower or stable energy prices. But due to the extremely hot summer that Europe is experiencing, food prices are on the way up, and inflation remains higher for a longer period than the bond investors are expecting. With the negative European interest rate, I continue to argue that the ECB is pursuing a monetary policy which simply enhances the risk of a sudden fire sale in the European bond market.
With the impressive U.S. GDP growth in the second quarter of 4.1 pct. (graphic one), the U.S. Federal Reserve Bank (Fed) is also challenged about when to hike interest rates next time. However, it is a positive problem, and the communication from the Fed to the financial markets is good, so there will hardly come any big surprises. Therefore, I keep my view that the next interest rate hike in the U.S. will be in September, unless the trade war starts to hurt the American economy deeper. However, the upcoming interest rate hikes from Fed will pressure the U.S. dollar higher also against the peso, unless Bangko Sentral ng Pilipinas shows the same power as other central banks do.