Slow Global Growth Likely Keeps Fed on Hold, Spurs ECB Action
The European Central Bank announced new stimulus plans and the Federal Reserve signaled more reluctance to raise U.S. interest rates this year
The European Central Bank made a U-turn on Thursday with new plans to stimulate the eurozone’s faltering economy, while Federal Reserve officials signaled increasing reluctance to raise U.S. interest rates at all, as evidence mounts of a slowing global economy.
The ECB, acting less than three months after it phased out a €2.6 trillion ($2.9 trillion) bond-buying program, said it would hold interest rates at their current levels at least through the end of this year—months longer than previously signaled. It also will issue a fresh batch of cheap long-term loans for banks starting in September.
Federal Reserve officials, meanwhile, appeared more cautious on U.S. interest rates. The U.S. economic outlook “appears to have softened against a backdrop of greater downside risks,” said Fed governor Lael Brainard on Thursday. “Prudence counsels a period of watchful waiting.” She made no mention of the need to raise interest rates, a shift from her position last year.
Investors quickly reacted to a ECB response to slowing global growth that was more aggressive than they had expected.
Shares slid, with the Stoxx Europe 600 falling 0.8% and the Dow Jones Industrial Average down 1%. The euro fell 0.4% against the dollar, as yields on Italian and German bonds declined, a sign investors are uncertain about prospects for growth and inflation.
As recently as December, the Fed, ECB and other developed economy central banks expected to raise interest rates this year because they projected solid global growth. The turnaround reflected a significant rethink of the outlook.
Negative interest rates in Europe and Japan, together with historically low nominal rates in other rich nations, leave central bankers with little room to cut borrowing costs to provide stimulus if their economies fall into recession. The fall of German 10-year bund yields to 0.09% from 0.12% is a sign of the continued extraordinarily loose lending conditions in the eurozone.
As a result, global central bankers appear to be moving preemptively to shore up flagging growth before any slowdown deepens.
The Bank of Canada on Wednesday held its key interest rate steady at 1.75%, and officials expressed more caution about the outlook while revising down domestic growth forecasts. Australia’s central bank likewise held its rate steady on Tuesday and warned of growing risks to the global economy.
China’s government has unveiled growth-enhancing efforts, including new tax cuts and increased bank lending to small and private companies.
ECB President Mario Draghi said Thursday the likelihood of a recession is very low, but risks to the economy remain prevalent. The ECB’s decision was unanimous, he said at a press conference.
“We never thought we were behind the curve,” Mr. Draghi said, and “in any event today we are not behind the curve, for sure.”
The Fed signaled in January it was moving to the sidelines after raising rates four times last year. As recently as December, officials had projected two more rate increases for 2019. Officials are set to lower these projections at their meeting in two weeks, likely showing either one or zero rate increases for the year.
The Fed’s January shift helped calm markets that turned more volatile last December, when trade tensions between the Trump administration and China flared and the federal government began a partial shutdown that lasted for 35 days, a record. The S&P 500 slid 11% between the end of November and Jan. 3, and it has rallied 13% since Mr. Powell first signaled the pause on Jan. 4. The index is 6% below the all-time high reached last September.
The Fed is also preparing to announce when this year it will end the gradual runoff of its $4 trillion asset portfolio, which will leave the Fed with a much larger balance sheet than officials had anticipated when they began shrinking the holdings in 2017.
Fed and ECB officials have pointed to rising dangers of slower global growth and political uncertainties exacerbated by trade disputes between Washington and several allies as well as the United Kingdom’s pending exit from the European Union.
Fed officials have also highlighted muted inflation readings in justifying their turn away from raising rates. Several U.S. central bankers have suggested the combined effects of higher borrowing costs and a fall in stock prices late last year and a slowdown in foreign economies could keep a lid on domestic price pressures.
Several Fed officials, meanwhile, have set a high bar to raise rates again, particularly now that the target range for their benchmark rate is at the low end of estimates of a neutral setting that neither spurs nor slows growth.
One camp has said rates are still below neutral, and their baseline outlook has the Fed raising rates once more this year.
Another camp has said it sees little need to raise interest rates so long as inflation isn’t rising above the central bank’s 2% target. San Francisco Fed President Mary Daly said in an interview last month that If her current outlook of 2% growth and inflation at or just under the 2% target is realized, “the case for interest rate increases is not there.”
Two top allies of Fed Chairman Jerome Powell have indicated their views may align with this latter camp. In remarks last week, Fed Vice Chairman Richard Clarida said it was appropriate for the Fed to step back from a framework that had guided rate increases over the last three years.
For years, officials moved rates up based on the theory that a falling unemployment rate would eventually generate price pressures and that, even with inflation running below its 2% target, the Fed needed to act preemptively to contain such pressures.
Mr. Clarida said last week that Fed officials must now focus on “maximizing the odds of being right given the reality that the models that we consult are not infallible.” For example, he said, “were a model to predict a surge in inflation, a decision for preemptive hikes before the surge is evident in actual data would need to be balanced against the considerable cost of the model being wrong.”
New York Fed President John Williams, another top lieutenant to Mr. Powell, said Wednesday he believed U.S. interest rates had nearly reached neutral and that he expected the domestic economy to grow at its 2% trend level this year. That outlook would be consistent with holding rates steady.
The ECB’s moves reflect sustained weakness in several economies. In 2017, boosted by its stimulus measures—including bond buying and negative interest rates—and a surge in demand for its exports from China and elsewhere, the eurozone’s economy grew at the fastest pace in a decade, outpacing the U.S. But it slowed sharply last year as those sources of support waned, growing at its weakest pace since 2014.
European officials are seeking to shore up an economy that has been rattled by shocks ranging from a slowdown in China to mass protests in France and bottlenecks in Germany’s crucial auto industry. They are treading a careful path between providing sufficient support for the region’s softening economy while avoiding any appearance of panic, which could ricochet through financial markets.
Still, the ECB refrained from more extreme measures such as restarting its bond-buying program or cutting its deposit rate further from minus 0.4%. These options weren’t discussed, Mr. Draghi said.
“In a dark room, you move with tiny steps,” he said.