Central Bankers Race to Protect Growth in 72 Hours of Crisis

Bloomberg

Central bankers are racing to shield their economies from fiscal tightening and lopsided currency swings that threaten a new global recession.

In the 72 hours after a Group of Seven conference call on Aug. 7, the Federal Reserve pledged to keep interest rates near zero through at least mid-2013, the European Central Bank intervened in bond markets and the Bank of England indicated it’s ready to add more stimulus if needed. Japan signaled renewed concern about the yen and Switzerland yesterday stepped up its fight to curb an “overvalued” franc.

“Central bankers have so far been the tower of strength,” said Stefan Schneider, chief international economist at Deutsche Bank AG in Frankfurt. “Lawmakers have done everything to destroy belief in their ability to solve the problems they’re facing.”

Today, the Bank of Korea kept interest rates unchanged for a second month and government officials planned a 2 p.m. local time media briefing in Seoul on the stock market rout. The MSCI Asia Pacific Index sank 1.1 percent as of 9:42 a.m. in Tokyo.

Finance ministers and central bankers from the G-7 nations, which include the U.S., U.K. and Germany, said in a statement Aug. 7 that they will “take all necessary measures to support financial stability and growth in a spirit of close cooperation and confidence.”

Buying Bonds

The next day, the Frankfurt-based ECB, which last week restarted its bond-purchase program after an 18-week hiatus, extended its focus to include debt of Italy and Spain, the region’s third- and fourth-largest economies.

The Fed’s decision Aug. 9 to hold its key interest rate at a record low through mid-2013 and signal it’s ready to use additional tools comes as U.S. politicians are tightening the nation’s fiscal belt and the economic stimulus enacted by President Barack Obama in 2009 comes to an end.

Bank of England Governor Mervyn King told reporters in London yesterday that headwinds buffeting the nation’s economy are intensifying “by the day” and officials can expand stimulus if the outlook for growth deteriorates further.

Bank of Japan Governor Masaaki Shirakawa said Aug. 9 that volatile exchange rates could have a “negative impact” on the economy, after the central bank last week added 10 trillion yen ($130 billion) of stimulus and the country unilaterally intervened in the currency market to weaken the yen.

Switzerland’s central bank said yesterday it will increase the supply of francs to fight the currency’s “massive overvaluation.”

Broad Push

While the actions aren’t as directly coordinated, the push is one of the broadest since the Fed, ECB and four other central banks cut interest rates together in October 2008 to limit fallout from Lehman Brothers Holdings Inc.’s collapse.

“Central banks are trying to get their act together,” said Mohamed El-Erian, chief executive officer at Pacific Investment Management Co., the world’s largest manager of bond funds.

“But we have to recognize that what they do is necessary but not sufficient,” El-Erian said yesterday on Bloomberg Television’s “In the Loop” with Betty Liu. “We need other agencies, whether in the U.S. or in Europe, to get their act together.”

Financial markets have delivered a mixed verdict so far. The Standard & Poor’s 500 Index, which has fallen in 11 of the last 13 days, dropped 4.4 percent to 1,120.76 at the 4 p.m. close in New York yesterday.

German Stocks Slide

German stocks declined the most since 2008, tracking losses across Europe. The DAX sank 303.66, or 5.1 percent, to 5,613.42 in Frankfurt for an 11th day of declines, the longest losing streak since 1978. The gauge has tumbled 26 percent since this year’s high on May 2.

Government bonds rallied in most of North America and Europe, with 10-year U.S. Treasury yields declining 0.14 percentage point to 2.11 percent at 5:02 p.m. in New York.

U.S. fiscal spending will decline by $42 billion in the budget year starting Oct. 1, 2012, twice the amount during the prior 12 months, according to the Congressional Budget Office. The deficit reduction package enacted on Aug. 2 calls for slicing the deficit by at least $2.1 trillion over 10 years.

‘Fragile’ Economies

Randall Kroszner, a former Fed governor, said central banks must consider the effects of fiscal tightening when making decisions about how to aid their economies.

“It is wise to be doing this kind of risk management because economic conditions have become more fragile,” he said.

With euro-region governments failing to act swiftly enough to stop contagion from Greece’s fiscal meltdown, it has fallen to the ECB to battle a crisis that’s now threatening the survival of the euro. The ECB has lifted its benchmark interest rate twice this year, to 1.5 percent to fight inflation.

Buying Italian and Spanish debt may require the ECB to massively expand its balance sheet and open it to accusations of bailing out profligate nations, breaching a key principle in the euro’s founding treaty and undermining its credibility. Within the ECB’s ranks, Bundesbank President Jens Weidmann voted against the resumption of the program; he was joined by Juergen Stark, Germany’s representative on the ECB’s Executive Board and representatives from the Netherlands and Luxembourg.

Bernanke’s Signal

In the U.S., Fed Chairman Ben S. Bernanke signaled that the central bank may consider a third round of large-scale asset purchases, even after the first two rounds totaling $2.3 trillion failed to secure sufficient job growth and sustain the two-year-old recovery. This week’s decision to leave its benchmark interest rate near zero through at least mid-2013 provoked three dissents from policy makers, the most opposition since Bernanke took office in 2006.

Even as they take action, central bankers “don’t know the panacea” and have disagreement within their ranks, Deutsche Bank’s Schneider said. “It’s increasingly unclear who can stop this spiral.”

A scholar of the Great Depression, Bernanke said last year that among the lessons learned from the financial collapse of the 1930s is that “policy makers must respond forcefully, creatively and decisively” and that “crises that are international in scope require an international response.”

“The wheels of fiscal change grind slowly, but central bankers can act more quickly” to address economic obstacles, said Alan Levenson, vice president and chief economist at T. Rowe Price Associates Inc. in Baltimore, which manages $521 billion in assets. “Central bankers are more nimble in breaking the negative feedback loop that’s developed between financial markets and the economy.”

To contact the reporters on this story: Jana Randow in Frankfurt at jrandow@bloomberg.net; Jeannine Aversa in Washington at javersa@bloomberg.net; Scott Lanman in Washington at slanman@bloomberg.net.

To contact the editors responsible for this story: Craig Stirling at cstirling@bloomberg.net; Christopher Wellisz at cwellisz@bloomberg.net