Central Banks Open The Spigots

¹²Central Banks Open Spigot
Stocks Leap As Japan Launches Bond Buying, Fed Official Urges More Easing

By Megumi Fujikawa In Tokyo and David Wessel In Washington | 6 October 2010

The developed world's central banks are moving— at varying speeds and intensity— to respond to a weak recovery, reduce the risks of deflation and restrain their currencies from rising against those of their trading partners. On Tuesday, it was the Bank of Japan's move. Anticipating that the U.S. Federal Reserve will resume large-scale purchases of U.S. Treasury bonds and confronted with strong domestic political pressure to spur growth and restrain a rising yen, the Japanese central bank launched a bond-buying program. It said it would spend ¥5 trillion ($60 billion) to buy government bonds, corporate IOUs, real-estate investment trust funds and exchange-traded funds— the latter two a departure from past practice.

"If a central bank tries to seek greater impact from its monetary policy, there is no choice but to jump into such a world," said Masaaki Shirakawa, governor of the Bank of Japan. Central bankers elsewhere are strongly indicating that they are preparing to open credit spigots to reflate their economies at a time when fiscal policy is stalled or contracting. In the U.S., Fed officials are signaling that the huge bond-buying effort they ended in March is likely to be resumed, perhaps as soon as its Nov. 2-3 meeting.

"The unemployment rate is too high; inflation is lower than what I think price stability calls for," said Charles Evans, president of the Federal Reserve Bank of Chicago, to The Wall Street Journal in an interview, echoing earlier comments by Fed Chairman Ben Bernanke and New York Fed President William Dudley. "If we were to do more large-scale asset purchases, namely Treasurys, that would have a beneficial effect."

Global stock markets are cheering. The Dow Jones Industrial Average rallied Tuesday to a five-month high, closing at 10944.72, up 193.45 or 1.8%. The Nikkei Stock Average rose Tuesday by 1.5%, its biggest gain in about three weeks. The central bank maneuvering comes amid intense focus on foreign-exchange rates.

Nearly every major economy is looking, to some degree, to restrain the rise in or push down the value of its own currency to give its exports some oomph. And the U.S., Japan and Europe all are seeking ways to pressure China to let its currency— widely regarded as undervalued— rise faster. Central bank easing generally pushes down a currency.

The Bank of Japan move was seen, in part, as a way to restrain the yen's rise in anticipation of Fed moves that otherwise would have pushed down the dollar (and the Chinese yuan, which largely tracks the dollar) against the yen. The yen fell initially after the Bank of Japan announcement, but rebounded to end the day roughly where it started: 12% higher against the dollar than at the start of the year.

A joint move toward easier credit by all the world's central banks could prevent any one currency from gaining an advantage. That prospect is contributing to a rise in gold prices. Comex gold for October delivery rose $23.50 per troy ounce, or 1.79%, to $1,338.90— a new all-time settlement high. There are risks, though. "If exchange-rate policy is being used in a way that would inhibit or otherwise thwart needed rebalancing of the global economy, then it would be detrimental to the broad goal of strengthening the recovery," the International Monetary Fund's deputy managing director John Lipsky said in an interview.

Emerging economies are enjoying much stronger growth than the U.S, Europe or Japan. For them, the moves by developed countries are causing unwelcome strains. Investors seeking higher yields are shifting money to emerging markets, putting upward pressure on their currencies and endangering their exports.

Brazil, in response, has raised a tax on foreign fixed-income investments to 4% to try to slow the flow. China, meanwhile, is coming under renewed pressure— on Tuesday, the source was the European Union— for refusing to let its currency rise more against the U.S. dollar. In Australia, its economy driven by a commodity boom, the central bank surprised markets Tuesday by keeping a key interest rate unchanged at 4.5%, though the governor, Glenn Stevens, cautioned that higher rates will be required at some point.

In the U.K., the Bank of England suspended its bond-buying in February, but left the door open to fresh asset purchases if conditions worsen. Some officials are ready to pull the trigger. "There remains a significant gap between what the economy could be producing at full employment and what it currently produces. Thus, policy makers should not settle for weak growth out of misplaced fear of inflation," committee member Adam Posen said recently.

The European Central Bank has avoided the large-scale asset purchases known as "quantitative easing" pursued in the U.S., the U.K. and Japan. But it has spent €63.5 billion ($86.9 billion) so far to buy government bonds issued by beleaguered members of the euro zone. ECB officials in public are more upbeat about the economy than their counterparts elsewhere, and more focused on the risks of inflation.

The readiness of some central banks to act contrasts with reluctance in most capitals to pursue more fiscal stimulus, largely because of public skepticism about its effectiveness and worries about already-large public debt burdens. Alan Blinder, a Princeton University economist and a former Fed vice chairman, likened the situation to having "one engine firing in reverse— at least if 'talking austerity' becomes 'practicing austerity.' In normal times, this would not be so bad, because the central bank can always put in more aggregate demand than fiscal contraction takes out. But once interest rates are near zero, the central bank is down to weaker instruments— and it could use help, not hindrance, from the fiscal authorities. The Fed is most assuredly in that position now."

Fed Chairman Bernanke, in a speech Monday, said "premature fiscal tightening could put the recovery at risk," but pressed the case for moving now to deal with long-term budget pressure. In Tokyo, which has debt worries of its own, the Bank of Japan has been under increasing pressure from politicians who threatened to curb its independence if it didn't do more to boost growth. It took a step last month to restrain the rising yen, agreeing not to offset the government's intervention in currency markets.

BOJ officials on Tuesday touted the fact that this time they moved before the Fed, but the move was modest in scale. The central bank said it would buy long-term bonds "with a remaining maturity of about one to two years," a sharp contrast to the Fed's past and likely future moves to buy longer-term bonds to reduce longer-term interest rates. The Bank of Japan also nudged down the target for its key overnight rate to a range of between 0.0% and 0.1%, from the previous 0.1% target, and said it would maintain a "virtual zero interest-rates policy" until the deflation threat dissipates and "medium— to long-term price stability is in sight."

"The effects of each of these measures might not be so substantial, but we are thinking that if we present this as a package, that might result in some kind of tangible effect," said a person familiar with the BOJ's thinking. He added that the BOJ sees Tuesday's move as the launch of an experiment. "This is the starting point," he said. "If this works, we may have a chance to increase the amount". Government officials, often critical of the BOJ for being too conservative, expressed satisfaction. "The BOJ's decision was appropriate and prompt" said Finance Minister Yoshihiko Noda.

But many analysts were unimpressed. "There's no doubt the BOJ tried its best today, but it's hard to see how the measures as a whole will help the economy very much," said Hirokata Kusaba, senior economist at Mizuho Research Institute. Analysts said the moves may do little to take the froth off the yen. "The surprise invited some yen selling, but I don't think the BOJ's move will be enough to produce any sustained yen weakening," said Masanobu Ishikawa, general manager of spot foreign-exchange trading at Tokyo Forex & Ueda Harlow.