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The Fed and ECB Confront a New Normal That Looks a Lot Like Japan's


By Rich Miller


  • Fed and ECB find it difficult to roll back their stimulus

  • Rates are low, balance sheets big -- and there’s no way out

Central bankers in the U.S. and Europe are reconciling themselves to a new normal of historically low interest rates and bloated balance sheets -- one that Japan has long since gotten used to.

The European Central Bank announced on Thursday that it will keep rates at record lows into next year, and restart a cheap loan program for banks, as a weakening economy derails its plan to withdraw stimulus. The Federal Reserve already put further rate increases on hold in January, and made clear it plans to stop reducing the $4 trillion portfolio of assets it built up fighting the financial crisis a decade ago.

“The developed world is at risk of mirroring the experience of Japan, whereby the very low equilibrium rate of interest appears to be a semi-permanent feature,’’ former Treasury Secretary Larry Summers and Bank of England Senior Economist Lukasz Rachel wrote in a paper published on Thursday.

The actions by the ECB and the Fed fanned speculation that the central banks’ efforts to return policy to what formerly would have passed for normal is ending and their next move will be to ease, not tighten, credit.

Policy makers in the U.S. and Europe are grappling with problems that have plagued Japan for decades: slow-growing economies and stubbornly low inflation, brought on by aging populations and lackluster gains in productivity.

Compounding the long-term challenges is an immediate one: a downshift in global growth centered in the manufacturing industry, and driven by concerns over trade frictions and by deleveraging in China.

Central bankers are hoping that the wobble will prove to be temporary -– as has been the case several times since the financial crisis ended in 2009. That would allow them to resume rolling back monetary stimulus.

If not, they will be left with precious little ammunition to fight the next recession, because interest rates will still be so low and balance sheets so big.

The difficulties are most acute in Japan, where rates arrived at zero 20 years ago. The central bank has pushed them into negative territory, and built up a balance sheet that’s bigger than the country’s overall economy –- and still growing.

That’s an ominous portent for the ECB, which said Thursday that it will delay raising its own negative rates at least until next year.

“There’s a strong probability that what happened in Japan two decades ago is currently unfolding in the euro zone,’’ said Andrew Bosomworth, a money manager at Pacific Investment Management Co. “It probably means the Japanification of capital markets -- lower yields for a longer time. Maybe forever.’’

Not Far Enough?

The ECB also slashed its forecast for economic growth this year to 1.1 percent from 1.7 percent, and indicated it won’t meet its target of having inflation below but close to 2 percent until after 2021. It’s a sharp turnabout. Just three months ago, policy makers ended their bond-buying program and expressed hope that the region could be weaned off crisis-era stimulus.

European stocks declined on Thursday as investors fretted that the ECB’s dovish turn didn’t go far enough. The euro sank to its weakest level against the dollar since 2017.

Europe’s central bank can’t manage alone, and its governments need to take budgetary action to boost the economy, according to Angel Ubide, head of economics research for Citadel LLC’s global fixed-income division. “The euro area needs a lot of fiscal stimulus,’’ he told a conference in Washington on March 5.

‘New Normal’

Fed officials are in much better shape than their counterparts in Europe and Japan. They’ve been able to lift interest rates from record lows and modestly reduce bond holdings.

But even they are having to adjust to what New York Fed President John Williams this week called the “new normal” -– a world where trend economic growth is slower, and interest rates are correspondingly lower.

He put the so-called neutral rate in the U.S. -- the one that neither holds back nor spurs economic growth -- at around 2.5 percent, in line with the Fed’s current target. That’s less than half the 5.25 percent rate going into 2007, before the last recession.

Winding Path

Other major central banks are finding it difficult to stop propping up their economies.

The Bank of Canada this week dialed back its conviction that interest rates will have to go higher, as officials expressed greater uncertainty about the outlook. In Australia, the central bank is under mounting pressure to ease policy in the face of a credit squeeze and tumbling property prices.

“It’s hard to think of a scenario where interest rates would need to go up this year,’’ Reserve Bank of Australia Governor Philip Lowe said on March 5.

At the Bank for International Settlements, the central bankers’ central bank, Claudio Borio says it’s getting harder to see what comes next.

The “monetary tightening process is on pause and has become less predictable,’’ Borio, who’s head of the monetary and economic department, said. “The narrow normalization path is proving to be a winding one.”

— With assistance by Sid Verma, and John Ainger


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