Central Banks Facing Challenges

Central banks across the developed world are facing a tough stretch: Months of political events—chief among them Tuesday’s US election—that will put their loose policies and their independence in the crosshairs.

If monetary policy becomes politicized, investors worry, financial-market turmoil could follow, news outlets reported.

With economic figures coming in strong, markets price in a 72% probability that the US Federal Reserve will nudge up interest rates in December. But some warn that a presidential victory by Donald Trump could upset such expectations, because of his repeated accusations that Fed Chairwoman Janet Yellen is keeping borrowing costs “artificially low” to benefit Democratic nominee Hillary Clinton.

“With his election campaign tirades, Trump undermines the Fed’s standing,” said Ulrich Leuchtmann, currency analyst at German lender Commerzbank AG. “It would therefore be quite understandable if in case of a Trump election victory it postponed a rate hike that was actually due.”

While Yellen has denied any influence of “partisan politics” in the Fed’s decisions, many analysts think attacks on central bankers could resonate.

Monetary Stimulus

Since the financial crisis, central banks in developed nations have deployed unprecedented waves of monetary stimulus, which have been effective at parrying financial shocks but have failed to significantly boost economic growth. Policies like government bond-buying, known as quantitative easing or QE, threaten to tear down the walls between politics and central banks—in Japan, many analysts argue they have already been breached under Prime Minister Shinzo Abe’s economic reflation plans.

The Japan central bank opted last Tuesday to leave policy unchanged, despite sharply cutting its inflation forecasts. And the bank doesn’t look likely to act in the coming months either as it backpedals to a less clear goal of maintaining “momentum” toward its 2% inflation target.

European Central Bank President Mario Draghi defended the central bank’s easy-money policies in Germany’s capital last week, arguing that ultralow interest rates haven’t harmed German households and stressing that the ECB would keep its policies in place until it reaches its inflation target.

The comments will reinforce expectations that the ECB plans to boost its €1.7 trillion bond-purchase program at its next policy meeting in early December. The program is currently due to expire in March.

And Governor Mark Carney said Thursday that the Bank of England is ready to tighten or ease monetary policy in response to inflation developments, dropping its earlier intention to cut the key rate to a new record low.

Double-Edged Sword

But the growing prominence of central bankers could itself be a double-edged sword: It may now set them up to take the fall for the economic ills that have fueled populist movements all around the world.

While few investors foresee a sudden end to central bank independence, they fear a war of attrition.

Nevertheless, investors are pondering whether political pressure—together with tentative signs of returning inflation—will push policy makers to deliver less stimulus. As a result, 10-year sovereign bond yields have risen roughly 0.3 and 0.5 percentage point in Germany and the UK respectively over the past month.

“We are in a calendar now with huge amounts of political events,” said Martin Horne, head of European high-yield investments at Barings. “We believe it will subdue a pace of aggressive monetary policy.”

Indeed, the European Central Bank is facing a complicated schedule. Next year, euroskeptic parties in France and Germany are expected to pose a challenge to the ruling governments. Because of his easy-money policies, Draghi has long been politically contentious in saver-fixated Germany.

Earlier this year, German Finance Minister Wolfgang Schauble accused the central bank of being responsible for “50% of the results” that the right-wing Alternative for Germany garnered in regional elections. Right after, Bundesbank President Jens Weidmann, a longtime critic of easy money inside the ECB, stepped up to defend the central bank’s independence.