Analysis: Coming full circle on monetary policy?

By Mike Dolan

LONDON (Reuters) – Reverberations will be felt for many years to come yet, but this week could mark another milestone in the passing of the credit crisis.

After three-and-half-years of extraordinary and unprecedented monetary policies to contain a global credit implosion, banking seizure and worldwide recession, western central banks look on the cusp of “normalizing” the way they manage the money in their economies.

With a quarter-percentage point rate rise expected Thursday, the European Central Bank looks set to pave the way for the G4 central banks, who control the four major world reserve currencies — the dollar, euro, sterling and yen — with resultant power over global money supply and liquidity.

The Bank of England is also set to follow the ECB this summer and U.S. Federal Reserve by yearend, debating an end to their latest money-printing programs in the interim. Japan may be moving deeper into cash-printing mode — but that’s most likely a one-off to offset last month’s devastating earthquake and may be reversed quickly as reconstruction takes root.

And so with global inflation spiking higher on the back of surging energy and food costs and the global economy booming at well over 4 percent annualized growth in the first quarter of this year, the big picture arguments for tighter money — or at least turning off the emergency money taps — appear obvious.

What’s more, scaling back of western money printing and nudging near-zero interest rates up could in turn allow some “normalizing” of monetary policies in emerging economies, too.

Fear of yield-hungry capital blowing asset bubbles and excessive currency appreciation forced many emerging economies to counteract “quantitative easing” by eschewing interest rate rises in favor of administrative measures to control credit-fueled inflation — so-called “quantitative tightening.”

China’s latest interest rate rise on Tuesday, its fourth since October, may be just a nod back in that direction, too.

“Globally, we expect a gradual shift toward more conventional monetary policies,” Barclay’s economist Frank Engels told clients this week.

And, for some, the interest rate baseline rises from here.

Morgan Stanley’s notional “global policy rate” for 20 of the world’s biggest developed and developing central banks is currently 2.5 percent, still far below world growth rates.

But it forecasts that rate to rise to 2.8 percent by yearend and 3.6 percent by the end of 2012.

A narrower cut, representing just the G10 developed economies, is just 0.6 percent. But that too is expected to nudge higher to 0.9 percent by yearend but then jump to 2.3 percent 12 months later.


One big question is that the ECB has been here before.

Even though it was the first central bank to recognize the scale of the banking and credit problem in 2007, flooding banks with almost 100 billion euros of emergency cash in August of that year, it then jumped the gun on higher rates in July 2008 and was forced into a U-turn when the crisis deepened further.

And there are many who think its inflation focus once again ignores brewing financial problems — this time the ongoing euro sovereign debt crisis and deepening austerity on the bloc’s periphery — and they fear Thursday’s move could be another blunder rather than a bellwether for its peers.

What for sure, few households and businesses in Dublin, Lisbon or Athens will thank the ECB for making their depressed economic climates of austerity and job losses even harder.

But with inflation across the euro zone running at more than half a point above target and the bloc’s largest economy Germany growing at its fastest rate since reunification 20 years ago, the bank’s primary mandate to preserve price stability across the region suggests it needs to act otherwise.

And it can do that without dropping unusual backstops for the ailing periphery.

But here the story moves from local to regional to global.

Inflation, as Axa Investments chief economist Eric Chaney insists, is now quintessentially global. Oil and food prices are being driven largely by aggregate global demand and both are buoyed by abundant global liquidity in the form of cheap money and risk-seeking global capital.

As long as the world economy continues to grow in excess of 4 percent, driven by both the broad western recovery as well as robust emerging economies, then it’s hard to see global price spikes being reversed any time soon.

In the first quarter of this year alone, Brent crude oil futures gained 25 percent and soft commodities jumped 10 percent. Corn prices, for example, have jumped 20 percent.

None of this inflation will do anything to make life easier in Portugal, Ireland or Greece and will only serve to depress real incomes even further while the poorest and the oldest dependant fixed incomes typically suffer most.

Unless world growth and demand are set to nosedive again soon — and there’s little in financial or economics world to suggest that now — then a gentle return to a more normal global developed and emerging monetary settings may be the best course.

Explicit or not, a broad understanding amongst the G20 top economies of this sort of sequencing may well be in play.

(Editing by Ron Askew)

Analysis: Coming full circle on monetary policy?