Watch what central bankers say, not what they do

LONDON Mon Feb 4, 2013 8:14am IST

Euro and U.S. dollar banknotes are seen in this picture illustration taken in Prague January 23, 2013. REUTERS/David W Cerny

Euro and U.S. dollar banknotes are seen in this picture illustration taken in Prague January 23, 2013.

Credit: Reuters/David W Cerny

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LONDON (Reuters) - Central banking is in a state of flux as policymakers from Tokyo to Washington ditch prevailing orthodoxies to try to grab a bigger share of a slow-growing global economic pie.

That's why the focus this week will be on what European Central Bank (ECB)Governor Mario Draghi has to say about the strength of the euro and what Canadian central bank chief Mark Carney might have in mind when he succeeds Mervyn King at the Bank of England (BOE) in July.

Draghi holds a news conference on Thursday after an ECB policy-setting meeting. On the same day, with delicious timing, Carney will be wrapping up testimony to British lawmakers just as the BoE announces the results of its own policy meeting.

The unanimous verdict of economists polled by Reuters is that neither bank will change its stance. The environment, however, is shifting, presenting both with unwanted challenges.

The ECB must keep a close eye on the euro, which has risen to a 14-month peak against the dollar and a 30-month high against the yen, reflecting the Federal Reserve's promise to keep buying bonds until U.S. unemployment falls much farther and the Bank of Japan's plan for a much looser monetary policy.

Exchange rates have much less of an impact on trade volumes than the state of external demand.

But, with global growth languishing, the relative performance of euro zone exporters will take a hit, said Daniel McCormack, a strategist at Macquarie in London.

"The euro could well be starting to cause a bit of pain already. It's moved up significantly, and in the context of what Japan's doing and the Fed's desire to get the dollar down or keep it low, it will have some impact," he said.


France has already complained about the euro's climb and Germany has blamed Japan for encouraging a weaker yen.

But Goldman Sachs said an ECB rate cut in response to a rising euro was still some way off, not least because the currency's vigour was largely due to improving economic and financial news from the euro zone.

The bank's economists did acknowledge, however, that the risks to its forecast that rates will stay on hold in 2013 were skewed to the downside.

"While global growth is picking up and demand growing, concerns about appreciation may be muted. But a strengthening euro in a stagnant global economy is likely to prompt questions about where the 'pain threshold' of German exporters to the level of the euro exchange rate lies," they said in a report.

Like the dollar, sterling has also fallen to a 14-month low against the euro.

British policymakers view a weaker pound as part of the solution to reviving the economy, which stagnated in 2012, and Goldman is among those who expect continued depreciation given the prospect of a more innovative and expansionary monetary policy under Carney.

McCormack reckons the shortfall in Britain's potential output that has opened up due to the recession is so great that the BOE might not need to contemplate tightening until 2018 - a full decade after the financial crisis climaxed.

But he said it was debatable whether Carney would prevail with his suggestion of targeting nominal gross domestic product, which implies permitting a temporary overshoot of inflation to allow growth to catch up.

"Most central bankers at the end of the day are in favour of strict inflation targeting. So he'll face a lot of intellectual pushback if he tries to get that through. But clearly there's the potential for some significant policy innovations once he's on board because he'll want to make his mark," McCormack said.


Central banks are not alone in rummaging around for new ways to spur growth.

European Union leaders, who hold a summit on Thursday devoted mainly to the bloc's budget, are expected to call for maximum efforts to reach a series of bilateral free trade pacts to lower tariffs and cut red tape throttling exports.

The prospects for talks with the United States and Canada are still up in the air, but leaders are likely to endorse an early start to talks with Japan, according to diplomats.

Trade figures happen to be the core of this week's global economic releases.

Britain's gaping goods deficit is forecast to show a small improvement, due in part to sterling's weakness.

China's imports are projected to leap, which would bode well for world growth.

But, like most early-year data from Asia, interpretation will be treacherous because of calendar distortions: Lunar New Year, when factories in China close en masse, falls this year on February 10, while last year the week-long holiday was in January.

America is likely to show a narrower trade deficit in December. Improving net exports would reinforce the view that the unexpected dip in GDP last quarter was due to fleeting factors and not the harbinger of a trend.

Bruce Kasman, an economist with JP Morgan in New York, said after Friday's good-but-not-great January jobs report that the economy was on track to expand about 2 percent this year despite fiscal drag that would lop at least 1.5 percent off growth.

Kasman said he was heartened by solid gains in labour income in recent months. Risks of a break-up of the euro, a hard landing in China and a plunge off the fiscal cliff in the United States had also been avoided.

All this pointed to steady if unspectacular U.S. growth.

"We don't have by any means the kind of growth that we would like, but we are setting ourselves up for a world where there's less risk and more sustainability," Kasman said on a conference call. (Editing by William Hardy)

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