CENTRAL BANKS STILL STEPPING ON THE GAS / THE FINANCIAL TIMES EDITORIAL ( HIGHLY RECOMMENDED READING )

Central banks still stepping on the gas

Published: November 5 2009 19:46

Central banks in Washington, London and Frankfurt have done what was expected of them by keeping policy rates unchanged. It was the only sensible thing to do. The US and parts of Europe may have returned to growth, but the recovery is brittle and rates of production still leave resources woefully underemployed. Inflation is subdued everywhere – even in the UK, where consumer prices, in spite of sterling’s fall, are up a mere 1.1 per cent in a year.

The banks were also right to signal they still expect interest rates to remain low. The Fed retained its “extended period” wording. ECB president Jean-Claude Trichet said “it is not our intention to change ”market rates’ attraction to the 0.25 per cent deposit rate rather than the 1 per cent main policy rate.

More suspense related to decisions about unconventional policy measures: the Fed’s credit easing and the Bank of England’s quantitative easing – programmes for purchasing securities – and the ECB’s unlimited provision of one-year liquidity to European banks.

By adding to demand for securities, the Fed and the Bank of England banks have tried to bring down yields from what they would otherwise be. Even with stable policy rates, therefore, their monetary policy has been easing throughout the year. The Fed has increased its holding of agency debt from $20bn to $142bn and bought mortgage-backed securities for $776bn since January; the Bank has purchased £175bn worth of gilts since March.

The UK easing will now slow somewhat: the Bank announced it would buy another £25bn of gilts over the next three months – and gilt yields rose as this was less than some had expected. The Fed, meanwhile, trimmed the amount of agency debt it plans to hold to $175bn, while restating a $1,250 ceiling on MBS, to be reached by the end of the next quarter. But this lets the Fed continue its shopping spree for the next five months at the same average pace as before.

There were hints at tightening. The ECB’s one-year facility expires next month; Mr Trichet, though refusing to be drawn on whether it will be prolonged, would not “dispel” market expectations that it will not. The Fed added qualifications to its statement hinting policy may change if conditions do.

Central banks can do little more than they are already doing to help recovery: pessimism and insolvency risk, not lack of liquidity, are holding output back. They can, however, derail it by tightening too soon or too late. That is why words matter: markets heed future plans as much as current actions.

Copyright The Financial Times Limited 2009.