Global Viewpoints: Sovereign Debt – ECB Shifts Monetary Policy Tactics as Bank of Japan Stands Pat
In the second of a four-part series, Portfolio Manager Ryan Myerberg outlines expectations for monetary policy at the European Central Bank and Bank of Japan.
While the European Central Bank has signaled an end to its asset-buying program, the Bank of Japan is expected to remain ultra-accommodative as it gauges the sustainability of economic growth against a background of weak inflation, says Portfolio Manager Ryan Myerberg.
- European Central Bank President Mario Draghi has announced an end to asset purchases by the end of the year after every European Union country returned to growth in 2017 for the first time since the Global Financial Crisis. However, interest rate hikes likely won’t happen until at least September 2019, and thereafter will depend on a return of inflation.
- While economic growth has improved, inflation materially below target means the Bank of Japan is likely to remain on an ultra-accommodative monetary policy path. However, the strategy faces potential structural and political risks.
- In part three of the series, Myerberg will examine the impact of U.S. dollar moves on emerging markets.
Myerberg: TWe have been very positive on the European, sort of, growth story. And looking at all the sort of underlying fundamentals, it’s been quite positive. So you’ve had all of Europe growing at the same time, which hadn’t happened since the sovereign crisis. You’ve had inflations gradually move higher. Core is still quite low but given the movement in oil, moving closer to target. The ECB has sort of forecasted that over their sort of horizon, their forecast horizon, they should get back to close but not quite, but less than 2% inflation. But there’s still fundamental weakness in the European economy and concerns about the sustainability of this above-trend growth that they’ve seen.
So what I think ECB President Mario Draghi has told us is, we are in a much better place than we were, say, five years ago. Growth is above trend, unemployment is coming down. But it’s not quite at the place where monetary policy can just go away and the eurozone can just continue on this path. So there are, unfortunately, sort of constraints for the ECB to stay accommodative forever. You have Northern European states that have said, “We aren’t in crisis mode anymore. We’re not in deflation or disinflationary mode anymore so this level of accommodation isn’t appropriate.” So the first step for the ECB, certainly given the issues about running out of bonds to buy, is to turn off the taps for the asset purchase program. And they’ve told us that by December, this program will be shut down. But going forward, we still have this sort of reinvestment policy so you have all of these bonds that are maturing in short duration that are coming off the books, coupons being paid. And that money will come back into the market. And so that’s kind of a, that’s a policy tool that is maybe a bit underappreciated. The ECB can use that as a volatility dampener. We have these issues in Italy percolating with politics and you’ve seen big sort of spikes in peripheral spreads. The ECB can use that program to dampen volatility. So I think Draghi’s looking at that as a sort of forward tool, and that’s maybe a bit underappreciated in terms of the dovishness of that. And they basically have told us that rates aren’t moving anywhere for the next, at least until September of 2019. And that is even data-dependent, so if you haven’t seen inflation come any higher, that rate isn’t moving.
We see the Bank of Japan in a very similar situation to the ECB, where growth has improved. It’s not where they want it to be. Inflation is materially below their target, that 2% target. But they’re finding themselves constrained with regards to their yield curve control and their ability to continually buy, expand their balance sheet as a sort of percentage of GDP. And it hasn’t really manifested in higher inflation or inflation expectations. So we expect the Bank of Japan to stay accommodative as long as possible, but we think there are risks to this policy.
Prime Minister Abe has been a big proponent of this aggressive approach from the Bank of Japan to get 2% as well as sort of more domestic fiscally focused Abenomics, that sort of three arrow approach to stimulating demand, stimulating the economy. But because the Abe administration is very scandal-ridden right now, and his approval rating has plummeted, you have the LDP, which is the party that he is in control of, has leadership elections in September, and there is a risk that if more scandals come out, and it’s not just hitting the Abe government, it’s hitting the Bank of Japan as well, that if Abe was to lose that leadership battle and you had someone come in who is less committed to this ultra-loose monetary policy, that the Bank of Japan may be forced to move to a more hawkish stance. It would be a significant issue in terms of global risk if you saw the ECB stepping away from providing liquidity in addition to the Fed, in addition to the Bank of Japan. So it’s not our base case necessarily, the Bank of Japan will turn off the taps, but it’s a risk that we have be focused on to get into the back half of the year with regards to 10-year being pinned at zero. It’s probably unlikely they’ll stay there for that much longer just because of the constraints that they face.
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