The Hindu Business Line : Central banks grope for ‘exit strategy’

‘Exit strategy’ is the current buzzword. It refers to the massive fiscal and monetary stimulus packages that governments and central banks were forced to inject into crashing economies and financial markets and the need to withdraw them as early as possible. No wonder, it topped the agenda of last week’s G-8 meeting of Finance Ministers.

How early or late this will happen has profound implications for stocks, bonds, currencies, commodities — in fact, just about everything.

Clearly, central banks were firing a warning shot to market players not to take soft interest rate policies for granted. Not that the latter didn’t know. As economic data out of the big economies improved (became less negative would perhaps be a more apt description), bond yields shot up in anticipation of a quick end to the near zero policy rates prevailing now. Another factor pressuring bonds is the rise in governments’ borrowing. The rise in corporate bond and mortgage rates could nip a nascent recovery in the bud.

Has the bond market got it right? Much will depend on the behaviour of inflation. So far consumer prices have been tame, thanks to the weak demand environment amidst the general economic slowdown. But some producer prices — those of oil, copper and aluminium, for example — are flaring up. Significantly, gasoline prices at the pump are rallying sharply. Increasing crude prices must pass through, but consumption should have normally dampened in reaction. The price action doesn’t suggest so.

Retail sales were better in May as are consumer confidence indices despite continuing job losses. Is it optimism that the heavy artillery deployed for a recovery will soon prove its fire power?

If inflation does surface, central banks will be caught between a rock and a hard place. But it is unlikely that they will be stampeded into reversing policy. Resumption of growth will remain the priority. There will be a willingness to tolerate some inflation and for longer – risk appetite is more.

Business investment in the rich countries will be tardy. As far as the US is concerned, the Obama package of public investment must kick in to fill the gap till the private sector steps in.

China has the buffer to jumpstart its economy and is doing all it can to substitute collapsed exports with home demand. Still, its impact will be limited to the commodity-producing economies.

G-7 growth prospects are in the slow lane, given the overhang of bad assets in bank balance-sheets and the dim chances of asset prices revival. System liquidity is yet to be fully put to work.

For central banks, ‘inflationless’ growth will provoke the interest rate trigger more than ‘growthless’ inflation.

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