Central Banks Turn to Unconventional Measures

After lowering interest rates to record low levels, leading central banks around the world are considering or already implementing quantitative easing monetary policies in an attempt to ensure sufficient money and credit in financial systems.

Today, it is expected that the Bank of England may lower the interest rate by half a percent, to a record low of 0.5 percent, and it is also expected to announce an increase in the money supply to pull Britain out of recession. The European Central Bank (ECB) is expected to lower its key interest rate by 0.5 percentage points, to a record low of 1.5 percent, but also to reduce its forecasts for the eurozone economy. Investors will closely monitor what ECB President Jean-Claude Trichet will say about possible next steps after the meeting.

Quantitative easing monetary policy, which Japan significantly applied from 2001 to 2006, refers to ways of stimulating economic growth after traditional monetary policy tools, such as targeted interest rates, have been exhausted. At that point, central banks flood banking systems with vast amounts of money, more than necessary, to keep interest rates low or at zero, thus supporting financial systems and encouraging lending. They usually do this by purchasing large amounts of assets from banks. The U.S. Fed is already implementing various programs to encourage lending, for example, by purchasing high-rated three-month commercial paper.

In January, however, it began a program to purchase $100 billion worth of direct obligations from leading U.S. mortgage lenders and $500 billion worth of mortgage bonds. The ECB has indicated that it is considering all options to expand its operations, but no decision has yet been made. As many as 40 percent of economists surveyed by Reuters expect the ECB to begin quantitative easing monetary policy in the coming months. The Bank of England has requested approval from the British government to formally initiate full quantitative easing, which will include the purchase of government bonds and other commercial papers using fresh money, valued between £40 billion and £150 billion. The Bank of Japan has not ruled out this option, but currently considers it unnecessary.

The central Japanese bank, however, is purchasing corporate bonds with a one-year maturity, worth $10 billion, and an equal amount of stocks from the portfolios of Japanese banks. The Canadian central bank announced on Tuesday that it will resort to quantitative monetary easing after lowering its key interest rate to a record low of 0.5 percent. The Swiss central bank is also considering unconventional methods to improve economic conditions, while the Israeli central bank will begin purchasing government bonds in the secondary market.

Meanwhile, on global stock exchanges, stock prices continue to slide, and due to expectations of interest rate cuts, the exchange rates of the euro and British pound have also fallen. The MSCI World Stock Index weakened by 0.1 percent and is again at its lowest level in six years. The euro exchange rate weakened by 0.6 percent, to $1.2592. “Given that the revised ECB growth forecast will reflect a weaker GDP and benign inflation, the euro could continue to weaken in the coming months,” says Daragh Maher from Cailon. The pound has slightly decreased against the U.S. currency, currently standing at $1.4196. (Hina)