19 June 2019

Central Banking Domino Effect Is In Motion

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Abrupt changes in the policies of the world’s largest central banks have rippled through smaller economies, leaving them with the prospect of low and even negative interest rates for years to come despite having mostly healthy economies.

The danger is that these easy-money policies could fuel destabilizing bubbles in real estate and other asset markets. They may also leave banks with little ammunition to respond to the next economic downturn.

Economies like Switzerland’s, whose central bank signaled no change in its negative-rate policies for years to come, are small compared with the U.S. and eurozone. Still, they are home to major global banks and companies that are sensitive to exchange rates and financial conditions. With financial markets so interconnected, problems in small countries can quickly spread to larger ones.

On Wednesday, the Federal Reserve left its key policy rate in a range between 2.25% and 2.5% and indicated that it is unlikely to raise rates this year. In late 2018, officials had signaled they expected between one and three increases this year.

Two weeks ago, the European Central Bank went further, saying it would launch new stimulus to support the eurozone economy via cheap loans for banks. It also said it expected to keep its key interest rate at minus 0.4% at least through 2019, a longer horizon than before.

The Swiss National Bank said Thursday that it would keep its policy rate at minus 0.75%, where it has been since January 2015, and reduced its inflation forecast to 0.3% this year and 0.6% in 2020. The SNB cited weaker overseas growth and inflation and “the resulting reduction in expectations regarding policy rates in the major currency areas going forward.”

Norway’s central bank took an opposite turn, raising its policy rate by 0.25 percentage point to 1% and signaled more increases this year. Norway’s reliance on oil production sets it apart from other European countries because higher oil prices provide a stimulus to its economy that its neighbors don’t receive. Its currency, the krone, rose about 1% against the euro after its decision.

Still, Norway’s bank lowered its long-term rate forecast, citing “a more gradual interest rate rise among trading partners.”

Norway’s central bank may not be alone in raising its key interest rate this year. While leaving its key rate unchanged Thursday, the Bank of England reaffirmed its expectation that “an ongoing tightening of monetary policy” will be needed if the U.K. leaves the European Union on agreed terms and with a period in which to adjust to new trading terms. But it also acknowledged that should Brexit be abrupt, a cut in its key rate might be needed.

Here’s why Fed and ECB decisions matter for countries that don’t use the dollar or euro: Switzerland and countries near the eurozone but not part of it—like Sweden and Denmark—rely on the bloc for much of their exports and imports. That makes growth and inflation highly dependent on the exchange rate. Central-bank stimulus tends to weaken a country’s exchange rate, so when the ECB embraces easy-money policies as it did two weeks ago it tends to weaken the euro against other European currencies such as the Swiss franc. Because the ECB is so large, Switzerland and others can do little to offset it

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