Central banks' balancing act

It's not just the Bank of Canada that is facing unprecedented uncertainty as it contemplates its policy decisions. Both the ECB and the Bank of England are in uncharted territory too.  For the Bank of Canada the great unknown is the fate of NAFTA; for policymakers in both London and Frankfurt, it's Brexit.

On Thursday both the ECB and the Bank of England indicated that they were maintaining their current policy stance for the time being, while being careful to acknowledge the risks that lie ahead.  In the case of the ECB, that means that the wind-down of the quantitative easing program that began at mid-year will continue.  Further, the Bank intends to keep its benchmark rate in negative territory (currently minus 0.4 percent) well into 2019.

While the Eurozone economy may not need the extraordinary stimulus of QE any longer, this is clearly not the time for the ECB to be tightening its more conventional policy settings.  GDP growth within the zone is starting to slow.  Uncertainties surrounding Brexit,  the situation in Turkey and the political turmoil in Italy, all overlaid by the Trump-initiated trade war, make it very likely that business investment will remain weak until the situation becomes clearer.  The ECB's job is made somewhat easier by the fact that inflation is under relatively good control; it currently stands at the target level of 2 percent but is expected to ease back in the coming months.

The task facing the ECB may be complicated, but it is as nothing compared to what confronts the Bank of England.  The Bank's unanimous decision this week was to maintain its asset purchase program (i.e. QE) at its current level, and also to keep Bank Rate at 0.75 percent. Despite the unanimity, this cannot have been an easy decision.  UK CPI has been edging above the Bank's 2 percent target for some time, standing at 2.5 percent in July.  There are signs that the economy is moving into a situation of excess demand, and the current 3.0 percent annual rise in wage rates is ominous, particularly in light of the UK's customarily weak productivity performance.

Overshadowing all these factors, of course, is Brexit, with the immutable fixed date for departure now barely half a year away and a deal on future arrangements nowhere in sight.  The Bank's press release notes that business uncertainty over the outlook is starting to mount, which is hardly surprising.  Bank Governor Mark Carney announced this week that he had agreed to extend his stay at the Bank from a current end-date of June 2019 to January 2020. He celebrated this decision by warning that in the event of a no-deal Brexit, house prices could fall by as much as 35 percent, a pronouncement unlikely to make him popular with the property-obsessed middle class.

Carney seems to have done a good job at the Bank, overcoming early resentment of him as a foreign interloper, as well as sniping from Tory Brexiteers who see him as a spokesman for the so-called Project Fear.  The next fifteen months, as he prepares himself for a return to the joys of an Ottawa winter (January, Mark?  What are you thinking??) will put to the test his reputation as the leading central banker of his generation.