Oil drop sends major central banks in different directions

Published Thu, Dec 18, 2014 · 01:02 PM

[FRANKFURT] The world's major central banks are scrambling to work through the implications of the near halving of the price of oil in the second half of 2014, and they are coming up with very different conclusions.

Perhaps unsurprisingly, policymakers looking at robust economic recoveries such as in the United States and Britain are focused on the likely boost to growth and consumption from markedly lower energy prices and the later upward impact that should have on inflation.

But for the European Central Bank, battling to revive a moribund economy, the worry is whether cheap oil could tip the eurozone into outright deflation.

As a result, low oil prices will likely widen the gap in monetary policy stances around the world, with the Federal Reserve mulling over the timing of a first interest rate rise while the ECB gets close to making the leap into bond-buying with new money, something the Fed stopped doing two months ago.

"Oil prices are important in terms of driving that monetary policy diversion," said Richard Barwell at RBS, a former Bank of England economist.

"Otherwise, we may just be having a conversation about the ECB not raising rates while the Fed raises. Whereas now, we're likely to have a conversation about the ECB buying assets on potentially a very large scale, and the Fed raising rates."

Fed officials acknowledged on Wednesday that inflation was likely to slow next year due to the oil impact but chose to look beyond that and gave a strong signal they were on track to raise interest rates sometime next year.

The US central bank said it would take a "patient"approach in deciding when to raise borrowing costs. Fed Chair Janet Yellen said that meant a rate hike was unlikely for "at least a couple of meetings," meaning April 2015 at the earliest.

The view from the US government is unambiguously positive.

"Lower oil prices are like a tax cut for the economy so in terms of the macroeconomic impact it's net a positive," Treasury Secretary Jack Lew said last week.

Bank of England Governor Mark Carney followed suit on Tuesday, labelling the fall in oil prices as an "unambiguously net positive" for Britain's economy and saying he would look through the direct effect of the fall in oil prices on inflation, which is running at just 1.0 per cent.

Britain's central bank also warned of heightened geopolitical tensions - Russia's rouble plunged on Tuesday despite a massive 6.5 percentage points interest rate rise - and destabilise eurozone inflation expectations.

But for the UK economy, the view was sanguine.

Contrast that with the ECB.

Italian ECB member Ignazio Visco said this week that the effects of oil on inflation "will be worse in coming months", perhaps pushing the ECB into full quantitative easing early next year.

ECB chief economist Peter Praet spelled it out in a speech in Washington last week saying that a miscalculation, leading to a de-anchoring of inflation expectations, would be dangerous.

"The question you have to ask yourself is when you have a shock, can you afford to be patient to look for the second round effects, which we traditionally do," Mr Praet said. "Do we have the luxury of waiting ... This is a question which is not settled." Bundesbank chief Jens Weidmann, the most vocal opponent of QE, conceded on Tuesday that inflation could turn negative but said this would not justify a broad sovereign bond-buying plan.

Mr Weidmann is in a minority, however.

ECB board member Benoit Coeure said in a newspaper interview on Wednesday that the bank's policymakers are discussing how best to act to revive the euro zone economy rather than whether to do so, with sovereign bond purchases the "baseline option".

There is a split within the euro zone, where stronger economies are more inclined to view the glass as half full.

Germany's Ifo institute revised up its expectations for growth in Europe's largest economy due to the falling euro and decline in oil prices and now expects growth of 1.5 per cent next year.

Mannheim-based think tank ZEW reported German analyst and investor sentiment rose sharply in December for a second month running for the same reasons.

For oil-producing countries the impact is more unambiguously negative. Russia is the prime example - and now has interest rates at 17 per cent to show for it in an attempt to shore up its currency. Norway's central bank unexpectedly cut interest rates last week, citing the negative impact on its growth from lower oil revenues.

The Bank of Japan is closer to the ECB's position than the Fed's.

The slump in oil prices is positive for an economy which imports a huge amount of fuel, but it makes the BOJ's 2 per cent inflation target harder to achieve.

Core consumer inflation is running at 0.9 per cent and some BOJ members think it will slow to about 0.5 per cent by the middle of next year as gasoline and electricity bills fall.

To stave off speculation of immediate action, the BOJ has started to emphasise the long-term benefits of oil prices. But the bank's nine-member board remains deeply divided on how much weight to give them in guiding monetary policy.

The rift, exposed by a 5-4 vote in favour of monetary easing in October, may mean Governor Haruhiko Kuroda struggles to convince the rest of his board to loosen policy again if needed in response to slowing inflation, analysts say.

All that means the new oil reality at least cements the divergent monetary policies the world economy is going to have to navigate next year - with US and UK interest rate rises likely at some point next year, while the ECB takes the QE plunge and the Bank of Japan debates whether to do more.

"There is definitely a divergent picture," said Berenberg bank economist Christian Schulz. "For the ECB, it would be dangerous now not to do anything."


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