The Strategist

Analysts: Fed and ECB provoked domino effect worldwide

03/25/2019 - 14:05

On Wednesday, the Fed left the key rate in the range of 2.25-2.5% and hinted that most likely it will stay the same in 2019. Meanwhile, at the end of last year, high-ranking employees of the Federal Reserve made it clear that in 2019 there would be one to three rate increases.

Public Domain Pictures
Public Domain Pictures
The ECB went even further two weeks ago. A new program to support the euro zone economies through cheap loans for banks was announced in Frankfurt. In addition, there were rumors that during the current year the base rate will remain at the level of -0.4%.

Sharp changes in the policy of the world's largest central banks spread in circles around small economies. By the way, most of them are quite “healthy”, but now threatened with the prospect of getting low or even negative key rates for years. The danger of easy money is to fuel the bubbles in the real estate market and in other sectors of the economy. Easy money can also leave banks defenseless in the face of yet another economic crisis.

Of course, economies like Switzerland, whose central bank emphasized that it does not intend to abandon the policy of negative rates in the near future, are too small compared with the economies of the United States or the euro zone. On the other hand, they include the largest banks and companies, which, naturally, depend on rates and financial conditions. Now financial markets are so interconnected that problems in small countries can quickly spread to large ones.

Swiss National Bank (SNB) said on Thursday that it would not change the key rate of -0.75%, which was set as early as January 2015, lowered the inflation forecast for this year to 0.3% and by 2020 - to 0.6%. These moves were explained by slowdown in the global economy and inflation.

Norwegian Central Bank took the opposite position: it raised the key rate by 0.25% and bringing it to 1%. Obviously, this will not be the last increase in 2019. Oil dependency makes Norway stand out from other European countries, because high prices for the material stimulate its economy.

The main bank of the northern kingdom, of course, is not the only central bank that raises rates. Although the Bank of England on Thursday did not raise the rate, it confirmed tightening of monetary policy in the near future, which will probably be needed after Brexit. The institution also acknowledged that in the event of a sudden withdrawal from a united Europe, drastic measures may be needed.

Such a dependence of countries outside the euro zone and currencies other than the euro or dollar (Switzerland, Sweden, Denmark) is explained by their dependence on exports and imports from the euro zone in this case. Relations with neighbors in the continent result in a high dependence of economic growth and inflation on currency rates. This means that when the ECB moves to the policy of easy money, as it did two weeks ago, the euro is falling against other European currencies.

The ECB is so big that Switzerland and other small countries are not able to fight it. On Thursday, the franc slightly grew against the euro, despite the fact that the SNB lowered its inflation forecasts.

Together with Switzerland, Sweden and Denmark have been pursuing the policy of negative rates for many years. Analysts are not expecting changes in these countries in the near future.

The policy of negative rates is expensive for commercial banks. In Switzerland, for example, commercial banks have paid SNB 7 billion francs ($ 7 billion) for keeping funds during three years. Over the four years, expenses of Danish banks amounted to EEK 3.1 billion ($ 0.5 billion). In Denmark, the key rate is 0.65% now.

Of course, the policy of large central banks affects not only Europe. On Thursday, for example, Lee Ju-yeol, director of Bank of Korea, made it clear that he paused tightening monetary policy. The last time the bank raised the rates in November 2018.