Major economies will be saddled with ultra low rates for years
Forget about a rising rate cycle, indications are interest rates will follow the Japanese example
Global markets are digging themselves into a deep hole. Sheer panic seems to be setting in over the spectre of world economic slowdown, chronic deflation worries and financial markets caught in a tail-spin. 2016 is shaping up as another painful phase of the seven-year-old global financial crisis.
The trouble is that global policymakers seem to be running out of fresh ideas to deal with this new leg of contagion. The major central banks have already deployed most of their monetary armoury in dealing with successive waves of the crisis since 2008.
Global central banks are close to running on empty. Interest rates have been slashed to rock bottom levels and a tonne of quantitative easing has already been thrown into the monetary reflation pile.
There is one very obvious clue to what happens next. Interest rates either need to go a lot lower or else the QE generators need to get cranked up again. The implication for markets is that the major economies will be saddled with ultra low rates for years.
It is causing mayhem for monetary policymaking and forcing rushed decisions. The European Central Bank is already setting the stage for another likely deposit rate cut in March, which will push euro zone rates even deeper into negative territory.
The Bank of England is also having second thoughts about monetary policy tightening and looks set to postpone a well-flagged plan to hike UK interest rates until at least 2017. The central bank believes the UK economic outlook is too fragile to sustain higher rates at this stage.
Deepening financial market turmoil will also stop the US Federal Reserve dead in its tracks on rate tightening. Despite the strength of the domestic economy and extremely positive employment trends in recent years, the US central bank is fretting again about the weakness of the global economy.
Worries about China and the fragility of emerging economies, especially Brazil and Russia, could put future US rate hikes on ice for a long while. And if conditions start to deteriorate much further, threatening to derail growth altogether, the Fed could be pushed into a dramatic policy U-turn. Last December’s rate rise would need to be reversed and the Fed might even need to consider kick-starting QE again to extend its bond-buying programme.
If the global slowdown starts to get out of hand and deeper deflation persists then interest rates around the world will continue to converge towards zero and remain that way for a long while. The Fed slashed rates near to zero at the end of 2008 and held them there for seven years. The same fate could befall other economies over coming years.
The experience of Japan in the last three decades is bound to resonate. From the mid-1990s onwards, Japan has struggled with episodes of recession, weak recovery and chronic deflation. Even after repeated rounds of government and Bank of Japan policy interventions the economy is still struggling. The legacy has been interest rates stuck at ultra-low levels for 20 years.
A global crash is not inevitable. Markets seem to be turning a drama into a crisis, but it is no hard landing yet. Growth in China may be at its weakest for 25 years, but it is still robust at 6.9 per cent. Underlying economic growth running around 2 per cent in the US and UK looks reasonable too. Even the euro zone’s underlying 1.5 per cent growth rate is far from being a disaster. Growth simply needs to be re-energised.
Global policymakers can call a halt to the slide, but they need to make a united stand, to think and act together. The ECB’s hint last week that it might add more monetary stimulus in March is a positive step, but more needs to be done by other central banks too.
The leading nations need a much more coherent and co-ordinated strategy to deal with damaging global headwinds. By working together through supranational bodies like the Group of Seven, G20 and International Monetary Fund, the leading nations can make a difference.
Better co-ordination of monetary and fiscal reflation on a broad front could turn the tide. And the major nations should avoid competitive currency devaluations which are little more than short term beggar-thy-neighbour palliatives.
The world economy can avoid becoming a victim again. Global policymakers simply need to pull together and promote the right remedies to beat the blues. Urgency is the watchword now.