CBs Worried About Potential Impact of Policy Tightening

As global economic growth gathers pace, with the International Monetary Fund reporting that all of the Group of 20 countries is now in an expansion phase, the world is at last entering a process of normalization of interest rates and monetary policy. That shift has been a long time coming, and in 2008 few would have forecast that the impact of the financial crisis that erupted that year would be so durable.

It is fair to say that policy normalization is proceeding at different speeds in different places. The US Federal Reserve is furthest ahead, having already lifted rates twice, while in the eurozone and Japan, normalization is more anticipated than experienced. But the general direction of change is clear, fnlondon.com reported.

In the Fed’s “Semiannual monetary policy report to the congress,” Fed Chair Janet Yellen forecast “gradual increases in the federal funds rate.” At the same time, the Fed is already reducing its holdings of US Treasury bills and mortgage bonds. In other words, so-called quantitative easing is being replaced in the US by QT, or quantitative tightening.

The European Central Bank has been less clear about its intentions, but has sounded notably more optimistic about growth in the eurozone, noting that all the job losses associated with the crisis have now been offset. A tapering of eurozone QE is now widely expected. For the Bank of England, Governor Mark Carney has emphasized the need to raise rates in the near future, given that UK inflation is well above target.

But it is clear that central bankers are nervous about moving rapidly, and are worried about the potential impact of policy tightening on financial markets. They are right to be anxious. Interest rates have been ultra-low for a long time. The last upward move in London was a decade ago. For most of today’s inhabitants of bank trading floors, that is ancient history.

They are persuaded that influencing expectations is critical. If markets expect a move, some of the needed adjustments will take place in advance, reducing the potential cost of change.

Central bankers have done a decent job of managing market expectations. There cannot be many people in the financial sector who will be surprised if the Fed raises rates again this year.

Consumer Debt Remains High

Preparing opinion for a move is more complicated in the UK. The voting system used by the BoE’s Monetary Policy Committee makes it harder for the governor to know when a majority for tightening will emerge, and some members’ views have been oscillating in recent months. Still, Carney has been doing his best to drop heavy hints about his own intentions.

But although financial markets may be prepared, can we say the same of individuals, households, and small businesses? Consumer debt remains high in many places, and certainly in the UK there are few signs that the prospect of higher interest rates is dissuading consumers from taking on more debt. There is clearly a risk that consumers may react more sharply to rate increases when they eventually occur.

Talk of a "hard Brexit" and a fresh fall in the value of the pound triggered a drop in UK consumer confidence in October, a new survey has revealed. The YouGov/Center for Economic and Business Research consumer confidence index fell to 109.3 from 111.5 in September.

Addressing Consumers Directly

Of course, central banks do not normally speak directly to consumers. They must rely on their messages being passed through several hands, including broadcasters and personal finance journalists, before they reach the high street. The BoE has made some recent efforts to address consumers, but its direct reach is inevitably modest.

And there is evidence that communications by central banks are not well suited to the consumer market. And this is a problem not only for the Fed. The minutes of the BoE’s Monetary Policy Committee are somewhat more demotic in style, but not much more. The Campaign for Plain English, a lobbying group, has described the bank’s statements as “worthless, impenetrable waffle”.

There are no comparable statistics or verdicts for the ECB, but one would be surprised if the results were any different. The results are a disappointment to central bankers, who, to their credit, have been enhancing their communications with the public in recent years.