Sub-zero central banks may just chase inflation expectations lower

Wed Mar 2, 2016 4:47am EST
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By Mike Dolan and John Geddie

LONDON (Reuters) - Hyperactive central banks warn of 'unmoored' inflation expectations but may well be weighing the anchor themselves.

Skewed by the oil price collapse of the past 20 months, headline inflation rates across Europe and Japan are currently near zero or even falling. Some economists now expect euro zone inflation for 2016 as a whole to be in the red and no longer dismiss the development as temporary monthly blips.

Fearful these low inflation rates might distort consumer and business behavior into putting off consumption today and wait for cheaper goods in future, central banks are scrambling to steer expectations back to inflation targets of about 2 percent.

And the only way they seem to be able to achieve that is by being as aggressive as possible in easing monetary policy to try and convince everyone they will eventually succeed in their goals.

The European Central Bank and its peers in Japan, Switzerland, Sweden and Denmark have all pushed their interest rates into negative territory and insist they will go further if needed. The ECB, for one, is widely expected to cut its minus 0.3 percent deposit rate next week by at least 10 basis points.

But if future inflation expectations are what policymakers are trying to buoy, it's not working and there's a growing chorus of concerns that negative interest rates may actually be feeding the problem.

By undermining banks' profitability - hence their balance sheets and willingness to lend - or even encouraging hoarding of physical cash to avoid deposit fees, financial markets at least have become unnerved about sub-zero interest rates and their unintended consequences.

"The road to Hell is paved with good intentions," said Pictet Wealth Management's head of asset allocation, Christophe Donay. "The implementation of negative interest rates by the BoJ and the ECB had quite the opposite result, rekindling deflationary fears through a shock to banks' profitability."   Continued...

The headquarters of the European Central Bank (ECB) is pictured in Frankfurt, Germany, July 15, 2015. REUTERS/Kai Pfaffenbach