The world's major central banks are painfully aware that they are nearing an important policy crossroads as they weigh the rising risks of maintaining historically low rates for too long.
When the Bank of Canada announces its latest decision tomorrow morning, its benchmark target is expected to remain at a record low 0.25 per cent, putting the central bank in the same camp as the U.S. Federal Reserve Board, the European Central Bank, the Bank of England and most of the developed world's other monetary policy setters.
No one disputes that the days of easy money must come to an end. But for now, most central bankers are keeping their fingers firmly on the hold button, as concerns about still-fragile economies outweigh fears that the unprecedented monetary stimulus is stoking inflation and fuelling new asset bubbles. This is expected to be evident this week as the Bank of Canada, the ECB and the Bank of England make their latest decisions.
Australia's central bank also meets this week, though it has been on a different path.
“We don't anticipate any rate increases from any of these central banks, outside of the Reserve Bank of Australia, until much later in the year,” said Sal Guatieri, a senior economist with BMO Nesbitt Burns.
With the economy expanding, private sector investment growing and unemployment falling, the Australian central bank boosted interest rates three times late last year to 3.75 per cent and is expected to do so again Tuesday.
Among other key central banks, it may well be the Bank of Canada that leads the stampede to higher rates, starting this summer, because Canada's economy and fiscal house are in considerably better shape than those of the United States, Britain or much of the euro zone, analysts say.
The bank's chief, Mark Carney, pledged last spring to leave the benchmark rate at its current rock-bottom level until at least mid-2010, depending on the inflation outlook.
With inflation still largely benign and the economy facing a hard road back to self-sustaining growth, the bank's call is an easy one.
“I expect to see that conditional commitment maintained,” said Eric Lascelles, chief economics and rates strategist with TD Securities. “It would be awfully surprising if it was abandoned just before it naturally matured.”
Other central banks never provided such clear direction to the markets so long in advance. The Fed, for instance, said only that it would not raise rates for an extended period. Now Fed chairman Ben Bernanke faces the tricky task of removing that language without leaving the market expecting an imminent rate hike.
Mr. Bernanke took pains last week to assure Congress there are no plans to raise rates, because the economy remains too feeble to stand on its own. The bank has also denied that an increase in its discount rate (charged to banks for short-term money) signals an imminent tightening of credit.
“They're preparing for their exit strategy, but they recognize that they're really not close to exiting,” said Robert Brusca, chief economist with FAO Economics in New York and a long-time Fed watcher.
But central banks cannot put off the day of reckoning much longer and they must hike rates aggressively to keep inflation in check, economists warn.
“If the Bank [of Canada] raises the rate only gradually and in small increments, inflation pressures will emerge,” Michael Parkin, a professor emeritus of economics at the University of Western Ontario, said in an e-mail exchange. “These pressures won't come through as faster CPI inflation for some time – probably not until late 2011 or early 2012. But they will influence other prices, perhaps that of housing and some durables, earlier.”
Eventually, as inflation expectations take hold, “the bank is backed into the corner of having to raise the policy rate above its long-term average and slow economic growth,” said Prof. Parkin, whose paper on the subject was released last week by the C.D. Howe Institute.
Prof. Parkin and several other central bank watchers also shot down the idea, championed by prominent Harvard economist Kenneth Rogoff, that the removal of fiscal stimulus should come before any monetary tightening, even at the risk of some inflation.
“The U.S. is in a state of paralysis in its fiscal policy. Monetary policy will tighten first, and I don't think it's the right mix,” Prof. Rogoff told a conference in Tokyo last week. “When they start tightening monetary policy even a little bit, it's going to send shock waves through the system.”
But what happens if the economy suddenly turns around and starts growing rapidly, Mr. Brusca asked. “Is the central bank supposed to wait and wait and wait until the growth has an impact on fiscal policy? It doesn't make any sense to me.”
Article by Brian Milner, Globe and Mail Update
Published on Sunday, Feb. 28, 2010 9:29PM EST
Last updated on Monday, Mar. 01, 2010 4:20AM EST