Morgan Stanley: Here's Why The Great Central Bank Tightening Cycle Came To A Premature End


Earlier this week Australia shocked the world when it left its key interest rates unchanged after a sequence of three hikes.

(That’s really not an exaggeration to say that it shocked the world, and it tells you something about the world we’re living in 2010 when something the Reserve Bank of Australia can make such huge news.)

And so while two or three weeks ago, we were talking about how the global tightening cycle had entered full swing, now we’re talking about how its already ended, or at least put on hiatus. Australia cited Chinese concerns in its decision.

But Australia wasn’t the only tightener, and it’s not the only one to pause early. The same goes for the Norges Bank (Norway).

Obviously, China is not the only issue here.

Morgan Stanley offers some more thoughts on the matter, which basically boil down to: the rate hikes weren’t accomplishing anything in terms of stopping bubbles:

These are not isolated incidents, in our view. All the
central banks who either had embarked on removing policy
accommodation in 2009, such as the BoI, the RBA and NB, or
were expected to begin raising rates early in 1Q10, such as
the Reserve Bank of India (RBI) and the Bank of Korea (BoK),
have refrained from hiking policy rates in their meetings so far
this year.  Korea’s strong recovery and extremely low policy
rates, and India’s economic bounce and the risk of inflation
made the central banks of these two economies front-runners
for hiking policy rates in early 2010. Yet none of these ‘front-
riders’ have made any fresh attempts to break away from the
pack this year. Why? We believe that the decision to raise
policy rates has to balance concerns about the domestic
economy against policy constraints of a global nature.
Headwinds from tightening ahead of the major central banks
have made it difficult for the policy action to gain traction.
Early-hiking central banks have had to deal with currency
appreciation and asset markets that have stubbornly stayed
buoyant in line with their counterparts in the major

Specifically, with regards to Australia:

The RBA is a case in point, having raised rates three times
already in this hiking cycle. Markets followed the RBA’s lead
and priced in a series of rate hikes into front-end interest
rates, but they also bid up the Aussie dollar (see Exhibit 1). By
contrast, stock markets and long-term interest rates in
Australia have barely noticed all of this action. Exhibit 1 shows
that stock markets and bond yields have stayed closely linked
to their counterparts in the US. Of the three early hikers, the
RBA has been easily the most aggressive central bank,
spurred by the resilience shown by the Australian economy. It
is certainly in a position to argue that its actions have taken
away a decent portion of the monetary accommodation and
that these rate hikes will have an impact on household
spending via variable-rate mortgages. However, the fact that
asset markets have not responded to even the most
aggressive central bank in this hiking cycle reflects the
difficulty that early hikers face in finding policy traction.

So basically these banks found themselves with all the drags of higher rates, and none of the bubble-cooling benefits. Raw deal.

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