One Policy to Rule Them All: Why Central Bank Divergence Is So Slow

The focus on the Fed raising rates masks the global easing in monetary policy

By Richard Barley

Left to right: Haruhiko Kuroda, governor of the Bank of Japan, Mario Draghi, president of the European Central Bank and Janet Yellen, U.S. Federal Reserve Chairwoman. Photo: Bloomberg News

Breaking up really is hard to do—if you’re a central banker. Talk of monetary policy divergence has proved to be difficult to turn into reality in a low-growth, low-inflation world.

Sure, the spotlight is on the U.S. Federal Reserve’s efforts to lift interest rates, especially as the policy shindig in Jackson Hole looms. But the bigger global picture is of yet more policy easing in developed economies. The headlines have been taken by high-profile actions this year like the Bank of Japan 8301 -1.81 % ’s introduction of negative rates, the European Central Bank’s bond buying and the Bank of England’s kitchen-sink response to Brexit.

But they are far from alone. In the past 12 months, the central banks of Australia, New Zealand, Norway and Sweden have all eased policy too, in some cases reversing earlier moves to raise rates.

Arguably, even the Fed has come into line with this trend. It entered 2016 brandishing as many as four rate increases; markets think even one increase is far from a sure thing. The change in those expectations alone accounts for a substantial dose of easing, reflected by the drop in long-term U.S. rates. Seen globally, the picture actually looks more like convergence than divergence.

Two big factors help explain this. The first is the contrast between global financial markets and the local policy settings of central banks. Countries with negative policy rates account for nearly 25% of global gross domestic product, Standard & Poor’s notes based on World Bank data. Because nearly any positive rate relative to zero looks high, even small moves to tighten monetary policy start to look like a big deal in financial markets. The prevalence of loose monetary policy is sending cash cascading across borders in search of higher returns—and pushing up currencies for higher-yielding markets.

That is increasingly affecting monetary policy. The Reserve Bank of New Zealand cited this factor directly in its most recent rate cut, even as it raised its growth forecast and worried about rising house prices. The Fed, in discussing longer-term monetary policy in its most recent minutes, noted that monetary transmission in the U.S. occurs through markets that are “quite globally connected.” A stronger dollar would have consequences for the U.S.—and for China and emerging markets, which have both benefited from the Fed’s reticence in raising rates and acted as a brake on its ambitions.

Second, the bond market appears to be content to play along. Deutsche Asset Management recently noted that all its investment ideas are “directly tied” to central bank policies, adding that it assumes that “we will not witness a rate-tightening cycle that deserves the name.” The power of low rates and quantitative easing appears to have stifled any dissent against the policy orthodoxy currently en vogue.

Low inflation globally is also at the heart of this conundrum and it remains a prospective source of disruption. One key reversal: oil markets have bounced sharply, meaning that for the first time in more than two years, the price for Brent crude is higher than a year ago. The global drag on inflation may fade.

But it may take time to shift a market mind-set that has appeared to discount the risk inflation will return. In the meantime, central banks are operating in what looks like a strange kind of global monetary-policy unión.

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