It’s easy to characterise monetary policy as a game of chicken.
Imagine Ben Bernanke driving in a car head on against ECB President Claude Trichet at 120 mph. Who will swerve first, tightening interest rates, and causing their currency to spike!? Who will hold bite their lip and hold out, keeping the pedal to the metal for the longest time, ensuring maximum stimulus? We’ll find out.
But maybe that’s a flawed games analogy.
Analysts at Morgan Stanley, in a new report, liken it to a peloton in a cycling race, where you’ve got the leader riders in the pack, willing to jump out in front of everyone else, and the rest of the pack, eager to draft off the lead riders, benefitting from decreased wind resistance.
At the front of the peloton… The front-riders – i.e., the early
hikers like the BoI (Israel), Norges Bank (Norway) and the RBA (Australia) – have more
flexibility right now. However, they face headwinds in their
attempts to take away some of the monetary easing that is in
place. First, risky assets are very strongly linked to their
counterparts in the major economies, so that financial
conditions will tighten less than they would have in other
cycles. Second, concerns about currency appreciation and
their impact on exports, particularly with global demand still
weak, will also deter aggressive action. It is interesting to note
that while these headwinds weaken the impact of policy
tightening right now, the situation will be very different when
the major central banks start their tightening campaign. Then,
the headwinds to tightening could turn into tailwinds, which
means that front-runners could find their financial conditions
tightening without doing much policy-wise, which in turn could
lead their currencies to weaken. Importantly, these headwinds
to the front-riders are a direct result of the über-expansionary
policy of the major central banks in the peloton.
So, who’s drafting behind them?
However, not everyone is eager to get a head-start:
Another group is eager to move firmly into the peloton to get
the most out of the liquidity benefits of riding with the
heavyweights. The central banks of Russia, Romania and
Hungary have been cutting rates aggressively recently and
are likely to continue to deliver more of the same (see page
20). Additionally, the RBNZ (New Zealand) in its last policy statement on
October 29 went out of its way to make a rather unusual
comment that markets were pricing in too many rate hikes.
Effectively, the RBNZ cemented its place firmly in the peloton,
content to get as much stimulus for its weak economy as it
can, given its benign inflation outlook (see page 10). Finally,
while markets have focused on the BoJ’s phased removal of
the corporate bond purchase programme as a sign of
tightening, our Japan economics team points out that the
more significant policy move on October 30 was actually a
further easing via the unprecedented use of Fed-like
commitments to “maintain the extremely accommodative
financial environment for some time” (our italics). Given that
the BoJ has a forecast of deflation for the next three years,
our economics team suggests that further rate cuts or bond
purchases should not be ruled out (see page 9).
As you can see above, the next round of leaders will likely include Canada, India, The Czech Republic, and Korea, followed later on by the EU, with the US only tightening later in 2010.