Central banks fret trade war more deflationary than inflationary

Singapore

GLOBAL central bankers sounded the alert that a trade war would leave them worrying more about the economic fallout than any boost tariffs would give to inflation.

As President Donald Trump threatens to impose levies on imported steel and aluminium and duties on as much as US$150 billion of Chinese goods, uncertainty over global commerce is casting a pall over an otherwise strong outlook.

The tensions were a key theme at the IMF meetings in Washington, with policy makers on Saturday warning of challenges in a communique. Colombia's central bank president said a trade war would be "catastrophic", his Paraguayan peer said it would be "bad for everyone" while Japan's chief described protectionism as "very undesirable".

Monetary policy makers may yet be spared such an outcome: US Treasury Secretary Steven Mnuchin said he's considering a trip to China, adding he's "cautiously optimistic" of reaching an agreement. That would take one cloud off the horizon, even as a massive pile of global debt and frothy markets threaten the current economic sunshine.

Should Mr Mnuchin's optimism fizzle, central bank chiefs may be left grappling with the stagflationary blow from tit-for-tat tariffs that push up inflation in the short-term as higher duties lift import prices and the drag on economic activity from the blow to confidence. That would suggest a need to keep monetary policy looser for longer.

"You have the direct effect on prices, of imposing tariffs, but you have the recessionary forces that will always generate significant downward bias in prices," Alejandro Werner, head of the IMF's Western Hemisphere department, said. "You would expect, if anything, looser monetary policy than in the base line."

Central bankers echoed that concern at a time when the IMF is forecasting global growth of 3.9 per cent this year and next, which would be the fastest pace since 2011.

A spiral of protectionism "would have a very big impact on growth", Colombia's central bank president Juan Jose Echavarria said in Washington. "It would be catastrophic for global growth. What we learned from the 1930s is that when all the countries start raising tariffs, economies stagnate."

So far, trade risk alone hasn't been enough to stop the turn of the global policy tightening cycle. The US Federal Reserve is set to hike its benchmark interest rate again by June and trade-reliant Singapore, which uses its exchange rate as its main policy tool, tightened the screws this month.

It could be that central banks keep tightening even amid talk of a trade war, said Rob Subbaraman, head of emerging markets economics at Nomura Holdings Inc in Singapore. He warned investors against the "illusion" of a "monetary policy put" - assuming trade risks are a reason to maintain accommodative policy.

Still, signs of a moderation in growth momentum in the first quarter are giving central bank chiefs reason for caution. Bank of England governor Mark Carney said market expectations for UK interest-rate increases may be too high and European Central Bank policy makers now see scope to wait until their July meeting to announce how they'll end their bond-buying programme.

Protectionism "will be very undesirable as the global trade and economy are finally expanding in a stable manner," said Bank of Japan governor Haruhiko Kuroda, who is forecast to leave policy unchanged at a meeting on Friday. "We have to be very cautious."

Even in the US, minutes of the Fed's March 20-21 meeting showed that a "strong majority" of participants saw downside risks to the economy from global trade tensions. Mr Trump's trade policies are also undermining previously robust consumer and corporate confidence.

ECB president Mario Draghi may have more to say on Thursday when he and fellow policy makers are predicted to leave monetary policy unchanged.

Worries even abound in those countries that might benefit from a spat between the US and China as demand is rerouted to their products. While he acknowledged soy exports could rise in the event of a skirmish, Paraguayan central bank chief Carlos Fernandez Valdovinos said "maybe it's beneficial for one sector, maybe for one year, but in the medium-term it's bad for everyone''.

Brazilian central bank president Ilan Goldfajn concurred. "If you provide me with two options - benefiting from this conflict, or not having this conflict and continuing the benign global environment - I would prefer to continue having the benign global environment," Mr Goldfajn told Bloomberg Television. BLOOMBERG