FX Daily: BIS reveal ugly truth behind global recovery

30th June 2014

  • BoE’s Cunliffe has warned over the dangers of raising interest rates too soon, saying the financial crisis and deep recession from 2008 did much damage to the economy. “(We’ve had) a very deep recession that did a lot a damage to the productive capacity of the economy”. (Telegraph)
  • BoE’s Bean underlined current policy thinking on the MPC saying he expects them to rise to around 2.5 or 3% over the medium term. (Sky News)
  • The ECB sees a longer period of very low inflation but no threat of deflation, according to ECB’s Yves Mersch. He believed rates will remain low for a long period of time, possibly through end of 2016. (Deutschlandfunk)
  • Germany’s draft budget is expected to avoid adding new debt in 2015, the “first time since 1969”. Fin Minister Schauble is expected “to demonstrate the benefits of structural economic change to its struggling euro-zone partners.” (WSJ)
  • In a newspaper opinion piece, Japan’s PM Abe has reiterated his commitment to the “third arrow”. On the much anticipated GPIF review he said the review “will be completed as soon as possible”. (FT)
  • The Japanese public is generally sceptical of PM Abe’s push to permit a larger military role for Japan, with a survey showing opponents to his plans for enhancing Japan’s military power outnumbering supporters. (Nikkei)
  • Yu Yongding, a senior economist with the Chinese Academy of Social Sciences, said the government should be alert to the risks of deflation when it is hard for China to keep the high growth rate of the past and high inflation is unlikely. (Shanghai Securities News)
  • Seven Chinese local government have unveiled plans to invite private capital to invest in projects, including in the infrastructure sector, with total investment at CNY1.5 trillion. (China Business News)
  • Spot iron ore prices may be set to rebound to around $110/tonne and stay at those levels for some time, according to Fortescue Metal’s CEO Stephen Pearce. (The Australian)
  • Japan May Industrial Output rose 0.5% on the month, undershooting median estimates of 0.9%.
  • Australian New Home Sales fell for the first time in 5 months, down 4.3% in May.
  • Australia TD Securities Inflation rose 0.3% on the month, 3.0% on year.

The Bank of International Settlements’ AGM provided a grim view of reality for financial markets this morning. For market participants who thought stock market record highs, low volatility and a frenzy of M&A activity was a sign of growth after a long recession, the BIS provides an alternative take on this market exuberance, mainly the dangers of ultra-low monetary policy rates and a global surge in debt. “Market participants, they said, may be taking more assurance than central banks wish to give” producing dangerous overconfidence in the markets with excessive risk taking. They also note that growth over the past decade has relied heavily on debt. The surge in debt has certainly helped to prop up demand but it contrasts sharply with low investment levels, raising questions over sustainability. The report zones in on the productivity puzzle of advanced economies, believing past financial booms led to a serve misallocation of resources that perpetuated a decline in productivity and thus secular stagnation. Economies need structural reform to correct this and right now ultra-low policy rates risk entrenching an equilibrium of “high debt, low interest rates and anaemic growth”. The report called on central banks to normalise policy and saw macro-prudential tools as no substitute to protect from financial imbalances. So as to provide no loop holes for central bank, the BIS downplayed below-target inflation believing it reflected “positive supply side effects” and was another sign that monetary policy had little traction in stimulating demand following a balance sheet recession.

The BIS’s remarks are certainly poignant for the Bank of England who recently introduced macro-prudential measures to combat financial instability in its housing sector in order to keep rates low for longer. With household debt to disposable income in the ranges of 140%, Governor Mark Carney admitted the UK was starting from a vulnerable position. However the Bank of England is not the only one risking housing sector imbalances to keep pumping up growth in the short-term. The BoE follows the example of its counterparts in Norway, Sweden, Switzerland, Canada and New Zealand. New Zealand is the only central bank so far to have combatted housing sector exuberance with a rise in headline rates. This occurred only after rising house price inflation trickled through into broader price pressures. However New Zealand is the exception rather than the rule. The economy benefitted from the Christchurch rebuild and surge in demand for its diary exports from China. New Zealand stands out among a global environment on slow growth, depressed inflation and low rates. The RBNZ raised rates for the first time in January and followed up with two consecutive rate rises at its next two meetings. Their commitment to normalising monetary policy surprised many as lower auction diary prices and a moderation in the housing sector darkened the outlook for economic growth. The RNBZ’s perseverance in tightening policy as well as placid data prints should see NZDUSD break clear above $0.88 in the near term. The newly dovish tone of the RBA could see further upward pressure on NZDAUD, although limited as most of this is already in the price. We watch GBPNZD to see if a more hawkish BoE against a steady RBNZ can turn the tide on this currency pair and lend support towards the £2.05 area.