Three major central banks are about to announce their monetary policy decision this week. Yet, the market is likely to focus on the big event scheduled one week for now – the U.S. elections.
The recession brought by the coronavirus pandemic caught economies at a bad moment. For instance, one of the ways a central bank reacts to an economic downturn is to lower the interest rate.
In doing so, it eases the monetary conditions and stimulates commercial banks to increase loans to businesses and the population. The market dynamics are such as an increase in the interest rate, triggers a decline in inflation. And a decrease in the interest rate generates higher inflation and even higher economic growth.
But in some parts of the world, the economy did not recover from the 2008-2009 Great Financial Crisis. More precisely, the European Central Bank (ECB) lowered the deposit facility rate below zero for several years now. When the coronavirus pandemic hit, the central bank suddenly faces a difficult task. On the one hand, the interest rate is already below zero. On the other hand, inflation and inflation expectations keep falling.
This is valid for all major central banks. Even the ones that did not lower the interest rate below zero, they did reach the lower boundary (i.e., zero level). The Bank of Canada or the Fed in the United States are such examples. As for the ones with the interest rate already below zero, we can name here the ECB, the Swiss National Bank (SNB), or the Bank of Japan (BOJ).
ECB in Focus This Week
The Bank of Canada and the Bank of Japan are announcing the interest rate decisions this week. With both banks having the rates already close to the zero level (one slightly above, one slightly below), the chances are that moving forward into the pandemic, they will keep them there. Or, they will lower them more.
This week’s focus is on the ECB. The central bank is expected to keep the monetary policy unchanged on Thursday and to act only in December. One of the reasons is the uncertainty that might come from the U.S. elections and the Fed’s decision next week.
But the ECB may be forced to act sooner. The European economies are strongly affected by the pandemic, and many of them restarted restrictions. Spain, Italy, and France imposed a curfew. Belgium’s infection rate is the highest in the Eurozone. What if the ECB cannot afford to wait?
Because it already has the rate at -0.5%, the ECB may indeed lower the rate further towards the -1%. But it cannot go much lower than that in the future without a severe damage to the credibility. Therefore, the way to act remains via bond-buying programs.
To sum up, negative rates are poised to remain lower for longer. Only after inflation picks up and economic growth as well we can see central banks thinking of tightening.
Until then, the easy monetary policy continues worldwide.
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