Friday, 5 July 2013

Unintended Consequences

Not a phrase central bankers would like to associate with.  

Just this week, shrugging off questions about his time at the head of the Finance Ministry when it entered into the budget flattering derivatives which have now been revealed to have lost the Italian government about $8 billion, Mario Draghi was able to team up with fresh faced new Bank of England Governor Mark Carney to talk markets up and interest rates (and currencies) down.  So far, so forward guidance (link here, although the FT was more sceptical, feeling a short term effect before rising US rates markets took the stage again).

In complete contrast Australian central bank governor Glenn Stevens had a proverbial foot in mouth moment (exacerbated by his deputy) - telling a "joke" about how much the rates committee had deliberated about holding interest rates at their last meeting (although with the door left open for likely declines soon).
The Reserve Bank of Australia’s deputy governor has been speaking on Thursday. Sadly there were no jokes but Philip Lowe did attempt to explain his boss’s side-splitting gag. 
But some people still don’t get the joke (which you can find on the RBA website).
Here’s a furious ANZ. 
"The Australian Financial Review reported an RBA spokesperson confirmed the RBA Governor’s comments yesterday that the Board deliberated for a very long time on Tuesday (before doing nothing) were meant as a “joke”, rather than a steer on policy. Presumably, however, the Governor would not be unhappy with the further fall in the Australian dollar to a new recent low that occurred partly as a result of this particular remark, but no doubt also as a result of the sober assessment of the challenges facing the economy in transitioning to other sources of growth amid considerably weaker mining investment over the next few years. 
The “joke” was important in our decision to add a further rate cut in August, changing the probabilities of an earlier move in our view (we had still been expecting a further cut later in the year). Given this information has been shown to be false, we should revert to our view of the day before yesterday that the RBA will cut rates again, but probably not until slightly later in the year as, for now, the currency is doing much of the easing work for the Bank and that the bias of risks for Australian official interest rates in 2014 is still assessed to be to the down side....(here)
Most would agree this has all gone a bit overboard.  But it raises a couple of points:

i) as noted in the quote Governor Stevens' statements were much more effective than many previous deliberatons in lowering the exchange rate (which has been a key objective with Australia finally entering the currency war of countries seeking to devalue their currencies).

ii) but central banker's main tool regarding market sentiment is their comments and misusing the tool could weaken it and cause adjustments by market participants (in the above quote ANZ is one example of such a participant).

iii) while the falling Aussie dollar is broadly welcome for Australia, it is not a fait accompli, if the dollar were to fall quickly, in adverse circumstances, it could trigger a loss of confidence which could exacerbate a crisis (such as might occur if there is a sudden withdrawal of hot money, or another meltdown in a big market nearby in Asia).  To lose control of the direction or tempo of currency policy would be a failure of the RBA (and currency management is a de facto remit of central banks in the era of currency wars).  High pitch fears of bears for the Aussie dollar (predicting future lows of US 75c are starting to resonate for some (here).

iv) even if there are no adverse outcomes, the overworking of the Governor's comments may blunt them as a tool in future (with market participants less responsive), making it harder for the central bank to steer policy in a crisis.  Which could be a big concern indeed..

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