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By HaleStewart March 8, 2014 2:01 pm
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International Week in Review: Peering Into the Mind of A Central Bank Edition

This week there were several important economic numbers, the most important of which was the 175,000 increase in the number of jobs in the US.  While the previous two months' figures were revised slightly higher, the 175,000 number helped to quell the mounting concern among traders and economists that the US economy was slowing.  We had two important numbers from the EU: 4Q13 GDP was reported at .5% Y/O/Y percentage change and a market manufacturing number of 53.2.  Both of these numbers added ammunition to the ECB's argument that a rebound was right on the horizon.  In contrast, the Chinese HSBC manufacturing number was 48.5, adding to concern that the economy was slowing down.  And finally, Canada had a net job loss number of 7,000. 

But the real news this week came in the form of several reports from major central banks on the underlying nature of their respective economies.  These reports give us important insight into what these various banks are thinking.  It is to these reports that we now turn.

The Federal Reserve issued the Beige Book, which described the US economy in the following terms:

Reports from most of the twelve Federal Reserve Districts indicated that economic conditions continued to expand from January to early February. Eight Districts reported improved levels of activity, but in most cases the increases were characterized as modest to moderate. New York and Philadelphia experienced a slight decline in activity, which was mostly attributed to the unusually severe weather experienced in those regions. Growth slowed in Chicago, and Kansas City reported that conditions remained stable during the reporting period. The outlook among most Districts remained optimistic.

For the duration of this recovery, the word most often used by the Fed to describe US economic activity is "moderate."  The above paragraph is no different.  Growth is neither too fast, nor too slow; instead, it is growing but not at a rate that would lead to inflationary pressure.  This also means the Fed is probably expecting continued improvement in the unemployment picture. 

The ECB also issued its policy guidance, stating:

Incoming information confirms that the moderate recovery of the euro area economy is proceeding in line with our previous assessment. At the same time, the latest ECB staff macroeconomic projections, now covering the period up to the end of 2016, support earlier expectations of a prolonged period of low inflation, to be followed by a gradual upward movement in HICP inflation rates towards levels closer to 2%. In keeping with this picture, monetary and credit dynamics remain subdued. Inflation expectations for the euro area over the medium to long term continue to be firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2%.

While many commentators have been arguing that current inflation rates are such that the region is risking deflation, notice the ECB is instead relying on staff economic projections.  According to this analysis, the current rate of inflation is to be expected as is the supposed pick-up in the inflation rate over the medium term.  The problem here is obvious: what if the predictions are wrong?

We also had the head of the Australian Central Bank make the following public statement regarding the Australian economy:

Turning to the Australian economy, for some time our view has been that growth has been running below its trend pace. The national accounts released a couple of days ago don't significantly change that assessment. For the year to the December quarter of 2013, real GDP rose by about 2¾ per cent. This is roughly in line with the forecasts we have had for a while. The drivers of growth are shifting. As we have been saying for some time now, and as confirmed in the recent survey of capital expenditure intentions by firms, the very high level of investment spending by mining companies has turned down, and the decline will accelerate over the coming year. Other areas of demand will provide at least some offset. Export volumes for resources are growing strongly, as the capacity that has been put in place by the high levels of investment comes on line. For example, iron ore shipments have risen by about 85 per cent from their levels of five years ago, to around 1.5 million tonnes per day. They will rise further over the coming year or two.


Consumer demand has had a firmer tone over the summer, after a fairly lengthy period of more subdued outcomes. This is evidence in the retail trade and national accounts data and is confirmed in information from the Bank's liaison. Consumer sentiment does still seem a little skittish, though, and while we expect consumption spending to grow in line with income or perhaps a little faster, consumers are unlikely to be the drivers of growth that they were prior to the financial crisis.

Like the Chinese economy, Australia is trying to alter the basic composition of its economic growth, moving from an economy dependent on resource development, investment and exports to one that is more evenly balanced between business and consumer spending.   According to the RBA, this change is slowing occurring, as low interest rates are encouraging increased asset prices and increased real estate investment.  However, the economy still hasn't seen the investment switch from that in raw material development  to other types and forms of business investment.  But, the sentiment signs that would be the presurer to such activity are there.

And finally, we have the following from the Bank of Canada:

In Canada, economic growth in the fourth quarter of 2013 was slightly stronger than the Bank anticipated, and upward revisions earlier in the year further raised the level of GDP. The Bank still expects underlying growth of around 2 1/2 per cent in 2014, with the current quarter likely to be softer. Exports have been a little stronger than previously thought but continue to underperform, and overall business investment has yet to pick up. Meanwhile, recent data support the Bank’s expectation of a soft landing in the housing market and stabilizing debt-to-income ratios for households.

On the whole, the fundamental drivers of growth and inflation in Canada continue to strengthen gradually, as anticipated. With inflation expected to be well below target for some time, the downside risks to inflation remain important. At the same time, the risks associated with elevated household imbalances have not materially changed. The Bank judges that the balance of risks remains within the zone for which the current stance of monetary policy is appropriate and therefore has decided to maintain the target for the overnight rate at 1 per cent. The timing and direction of the next change to the policy rate will depend on how new information influences this balance of risks.

Canda, like the US, is growing at a slow rate with little inflationary pressure.  And like the US, the potential for deflation is clearly on the Bank of Canada's mind.  There is also the expectation that growth will pick-up in the near future to a level more in line with potential growth.  

So -- what does all of this tell us?  First, no country is growing at a pace indicating a rate hike is near.  Instead, growth is moderate and below trend with a fair amount of slack in the economy.  Secondly, inflation is not a threat to anyone.  Therefore, the sum total of all this is most central banks will stand pat at their current policy levels, barring a major change in the economic numbers.

Hale Stewart is a former bond broker who has been writing about economics and financial markets since 2006 on the Bonddad Blog.  He is also a tax attorney with a domestic and international practice while also forming and managing captive insurance companies for US companies.   You can follow him on twitter at:@captivelawyer




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