Inflation target uncertainty magnifies price shocks’ impact- BoI paper

By Central Banking Newsdesk | Research | 16 August 2019

Researchers investigate effects of central banks failing to pefectly follow targets

A working paper published by the Bank of Italy paper looks at the impact of uncertainty about inflation targeting on the real economy. 

In Disinflationary shocks and inflation target uncertainty, Stefano Neri and Tiziano Ropele use a small‐scale New Keynesian model to study what happens when a central bank’s inflation target is not perfectly observed by the central bank itself, and by other agents. 

They find that under these conditions, disinflationary cost-push shocks have a negative impact on output. These shocks are larger when monetary policy is operating at the effective lower bound, the authors say. The central bank can reduce the negative effects of these shocks by eliminating some of the “noise” around the perceived inflation target. 

The authors say that their results are robust to varying both the degree of habit in consumption and the indexation of prices to past inflation. 

Future research, they say, could look at the implications of their research for countries with different degrees of transparency around inflation targets. Such research could exploit the effects of price shocks common to different countries, like those caused by oil supply.

Shale oil boom has not shifted global supply- ECB paper

By Central Banking Newsdesk | Research | 16 August 2019

Global oil supply appears to be “rather vertical” at all times, researchers find

The rapid recent increase in the production of shale oil does not appear to have significantly changed the fundamentals of global oil supply, a working paper published by the European Central Bank argues. 

In Much ado about nothing? The shale oil revolution and the global supply curve, Claudia Foroni and Livio Stracca start from a stylized model of the market. This has two producers of shale oil, “one facing low production costs and one higher production costs but potentially lower adjustment costs, competing a la Stackelberg”. 

The authors find that in these conditions the supply function is flatter for the higher-cost producer. Supply functions for shale oil producers become more demand-elastic as adjustment costs decline, they find. The authors then carry out an empirical analysis of the shale oil market, using an instrumental variable approach that uses estimates of demand-driven changes in oil prices. 

“A main finding is that global oil supply is rather vertical, practically all the time,” the authors write. The global oil market does not appear to have shifted to a more price-elastic supply as a result of the shale oil boom. 

ECB shuts down Latvian bank involved in Rimšēvičs affair

By Central Banking Newsdesk | News | 16 August 2019

Small lender's owner accused central bank governor of extortion and sued regulatory authorities

The European Central Bank, Frankfurt

The European Central Bank has effectively closed down the small Latvian commercial lender where senior executives made accusations of serious wrongdoing against the country’s central bank governor.

The ECB took over the direct supervision of PNB Banka on March 11 at the request of the Latvian regulatory authorities. Latvia’s Financial and Capital Market Commission, or FKTK, said that it had made the request after PNB Banka started legal action against it and the Latvian central bank. The bank was much smaller than the eurozone lenders the ECB normally directly supervises.

The ECB’s supervisory mechanism said that it had found that the bank was “failing or likely to fail”. It added that the Single Resolution Board had judged that it was not in the public interest to put the bank into a resolution process.

In a statement, the ECB said that the bank had been in breach of capital requirements since April 2017. The ECB said that the bank was privately owned and had reported deposits of €472 million in the first quarter of this year.

It remains to be seen how the bank’s closure relates to the complicated and continuing story of the unproven allegations that its founder made against Latvia’s central bank governor.

In February 2018, Bank of Latvia governor Ilmārs Rimšēvičs was arrested in February 2018 by the country’s anti-corruption authority Knab. He was arrested after shareholders in the defunct lender Trasta Komercbank accused him of having tried to extort bribes in return for favourable supervisory rulings.

Shortly afterwards, news reports revealed that PNB Banka’s founder Grigoriy Guselnikov had filed court papers making very similar accusations against Rimšēvičs. The long-serving central bank governor has persistently and strongly denied all accusations of wrong-doing.

Rimšēvičs was initially barred by Latvian courts from entering central bank premises, using the Bank of Latvia’s computers or leaving the country. But Rimšēvičs, supported by the ECB, appealed against this ruling at the European Court of Justice, which overturned the Latvian court’s judgement.

Latvia’s anti-corruption police bureau, Knab, has filed a case against the central bank governor with the country’s courts. A second major scandal enveloped Latvia’s financial system, again in February 2018, when the US Treasury alleged that one of Latvia’s largest lenders, ABLV Bank, was involved in massive money-laundering. The ECB closed the bank down when it became clear that US authorities would not advance dollars to it.

The combined impact of the two scandals led Latvia’s government to pass a law entirely replacing the top management of the financial regulator, the FKTK, and changing its governance. The scandals were also cited by senior European Union officials who called for major changes to the bloc’s approach to money-laundering.

ECB website stays down after hacking attack

By Central Banking Newsdesk | News | 16 August 2019

Hackers reportedly put illegal “phishing” software on BIRD website, which is operated by third party

A website operated by the European Central Bank was still not available today (August 16) after it was reportedly attacked by hackers.

The ECB runs the Banks’ Integrated Reporting Dictionary website. The website was shut down on August 15, the ECB announced, after a hacking group attacked the site. The ECB said the site would remain down until further notice.

The ECB said that the website was hacked into several months previously, but the attack was only discovered “late last week”. The ECB said the BIRD website is hosted by a third party and does not use the central bank’s own external and IT systems. The ECB said the hackers had not gained any access to any of the bank’s own sensitive data or internal systems.

The hackers put phishing software on the website, the ECB said, to gain access to confidential data and payments services. “The affected information consists of the email addresses, names and position titles of the subscribers,” the ECB statement said.

The ECB said it had contacted the 481 subscribers to the website’s newsletter, and had reported the matter to the European Data Protection Supervisor.  

IMF staff praise Dominican Republic’s central bank

By Central Banking Newsdesk | News | 16 August 2019

Policy changes increased central bank’s credibility in anchoring inflation expectations, IMF staff say

Banco Central de la República Dominicana with artistic pipes

The Dominican Republic’s central bank has made considerable progress in strengthening its monetary policy framework and foreign exchange infrastructure, International Monetary Fund staff said.

The central bank should build its foreign reserves further, the IMF staff said in their report published on August 15.

The central bank’s introduction of inflation targeting in 2012 and its recent adoption of forward targeting have both boosted its credibility, the report said.

“Inflation performance, in terms of level and volatility, has improved significantly since this shift in policy,” the IMF staff argued.

Before the target was implemented, inflation volatility was close to 1.6% compared with 0.4% for the key inflation targeters in the region, like Brazil, Chile, Colombia, Mexico and Peru, the IMF staff say. Since 2012, it has been close to 0.2%, in comparison to roughly 0.4% for the other inflation targeters in the region, the report finds.

The IMF staff also welcome the planned introduction of a foreign exchange platform. “In the absence of the electronic trading platform, the central bank cannot monitor the foreign currency market in real time, which makes it harder to interpret the main drivers behind market movements and introduces unnecessary volatility in a relatively shallow market,” the report says.

The central bank also hopes to promote greater use of foreign exchange derivatives, the report says.

The central bank had planned to launch the platform in June, but it is unclear how far it has progressed. The bank did not immediately respond to a request for more information on the platform’s development.

Since 2010, the central bank has considerably dramatically reduced its foreign exchange interventions. Purchases and sales has fallen from roughly 6–8% of GDP, respectively, in 2010 to roughly 1–3% of GDP, respectively, in 2018.

Reserve accumulation

The central bank’s international reserves have increased to 68% of the IMF’s reserve adequacy metric compared with only 28% in 2012, the report shows. Currently, the bank’s international reserves are roughly 10% of GDP, up from less than 5% in 2008, a graph in the report shows.

The IMF report recommends reserves to be 100–150% of the adequacy metric.

While the central bank’s external position “weakened somewhat” in 2018 it remains solid, the report says.

The current account deficit averaged 0.9% of GDP from 2016–18, “well below” its historical mean, IMF executive director Alexandre Tombini said. A graph in the report shows the deficit ranged from roughly 2.5% to nearly 10% of GDP since 2005.

The improvement has been driven by high external demand, especially for tourism, the depreciation of the currency and strong remittances, the report says.

IMF staff highlight that the accumulation of reserves will be constrained by the “costs of sterilising the reserves”. This is because the central bank holds low interest bearing foreign currency and high interest bearing domestic currency, creating a “negative carry for reserves”, the report says.

Mexico cuts rates for first time in five years

By Central Banking Newsdesk | News | 16 August 2019

Economy has had weakest first-half growth in six years, Dallas Fed reports

The Bank of Mexico

The Mexican central bank lowered its policy rate for the first time in over five years on August 16.

The Bank of Mexico reduced the overnight rate by 25 basis points to 8%, citing downside risks inflation and weak first-half GDP growth.

A recent report from the Dallas Fed, which regularly monitors the Mexican economy, shows Mexico has had the weakest first-half growth in six years. The report also notes weaker export growth, falling production and June job growth near zero. 

The Bank of Mexico’s statement also noted monetary easing by other central banks, including the Federal Reserve’s recent rate cut, as reasons for its decision.

The move represents the end of the central bank’s hiking cycle, which started in December 2015, with the last hike being in December 2018 to a 10-year high. The last time the bank reduced its policy rate was in June 2014, when it cut by 50bp to 3%.

While inflation is currently at 3.78%, within the central bank’s target range of 2–4%, it has fallen from 4.41% in April. 

The central bank statement highlighted downside risks to inflation coming from a potential peso appreciation following of more accommodative monetary policy worldwide. It also noted risks stemming from uncertainty surrounding the country’s trade relationship with the US.

Mexico’s peso has depreciated by roughly 1.9% against the dollar since the Fed’s July 25bp cut.  

The Bank of Mexico’s statement also pointed to some upside risks to inflation, from recent wage rises and potential further tariffs imposed by the US.

In December 2018, Mexican President Andrés Manuel Lopez Obrador raised the minimum wage and reduced taxes in some cities along the US-Mexico border.  

Incoming data on the second quarter growth suggest “stagnation of economic activity in Mexico observed in the previous quarters continued,” the central bank says. “Slack conditions in the economy have continued to loosen, even more than expected, widening the negative output gap,” it says.

Mexico’s GDP expanded by 0.4% in the second quarter after contracting 0.7% in the first. Prior to the latest figures being released, the central bank projected growth for this year to be 1.1% in June, down from 1.3% in May. The economy grew by 1.7% in 2018.

The International Monetary Fund also recently downgraded its growth forecast for Mexico in 2019, from 1.6% in April to 0.9% in July.

Mexican unemployment was at 3.6% in July, up slightly 3.5% June and 3.2% in April.

PBoC goes back to open market operations

By Alice Shen | News | 16 August 2019

Official figures show sharp drop in new loans extended by Chinese banks in July

The People’s Bank of China injected cash into the country’s financial markets through open market operations for the fifth day in a row today (August 16).  

The PBoC resumed its open market operations after halting them for more than two weeks from late July. The liquidity boost came after the PBoC reported that new loans fell in July August 12.

The PBoC said it conducted a total of 300 billion yuan ($42.6 billion) of seven-day reverse repos from August 12–16. It also lent another 400 billion yuan to financial institutions via its medium-term lending facility (MLF) on August 15.

Chinese banks made new loans worth 1.06 trillion yuan ($150 billion) in July, the PBoC said. This figure was a 27% decline year-on-year, and a drop of 36% from the figure for June 2019.

The falling new loans suggest that the monetary policy transmission is not working as expected, says Li Zhan, an economist with Guangdong-based Zhongshan Securities. “Low rates in the interbank market and high funding costs for small and privately owned firms exist at the same time.”

The dilemma means the central bank may resort to more targeted easing such as lowering reserve requirement ratios for smaller banks, says Li.

The PBoC said it would keep monetary policies “neither too tight, nor too loose”, in its second-quarter monetary policy report, issued in early August. After the US Federal Reserve cut policy rates on August 1, the PBoC did not follow suit.

The interest rate for the PBoC’s seven-day reverse repo stayed at 2.55%, while the rate for one-year lending facility remained at 3.3%.

The reverse repos and medium-term lending facilities were to offset the impact of the corporate tax period and MLF loans maturing during the week, the PBoC said in a statement on its open market operations.

The yuan’s recent depreciation against the US dollar makes it less urgent for the PBoC to lower interest rates, said Lu Zhengwei, chief economist of China’s Industrial Bank.

“This round of yuan weakness is equal to a 97-basis point cut of benchmark rates, as shown by models,”  Lu said.

RBNZ publishes debt-to-income dataset

By Central Banking Newsdesk | Official Record | 16 August 2019

Data provides insight into how households might react to a financial shock, central bank says

The Reserve Bank of New Zealand published a new debt-to-income (DTI) dataset on August 12, showing information on mortgage borrowers.

 “The DTI statistics we’re publishing today give an insight into the ability of homeowners to service their mortgages,” head of data and statistics, Steffi Schuster, says in the statement.

The dataset presents monthly information going back to June 2017.

“DTI data can be viewed alongside other information to give richer insights into New Zealand’s housing market,” Schuster says. “For example, by comparing DTI figures with loan-to-valuation data, we can better understand risks from households with a combination of large loans relative to the value of their property, and large loans relative to their income.”

Nigerian president tells central bank to stop funding food imports

By Central Banking Newsdesk | News | 15 August 2019

Consequences of Buhari’s order are unclear but Nigeria imports large quantities of food

Nigeria’s president has ordered the country’s central bank not to make foreign currency available to fund food imports.

President Muhammadu Buhari’s drastic policy change was announced on August 13 in a message from his official spokesman on Twitter. Buhari “disclosed that he has directed the Central Bank of Nigeria to stop providing foreign exchange for importation of food into the country, with the steady improvement in agricultural production, & attainment of full food security,” his spokesman’s Tweet said.

It is unclear what the consequences will be if the Central Bank of Nigeria (CBN) under governor Godwin Emefiele, obeys Buhari’s order. Nigeria imports large quantities of basic foodstuffs and could suffer major shortages if all food imports are suddenly halted.

The CBN makes foreign currency available to different industries to buy imports, including food. Emefiele announced in July that the CBN would no longer provide foreign currency to buy milk and other dairy products. It seems that there has not yet been time for the consequences of that ban to become apparent.

Both Buhari and Emefiele have said that the country must diversify its economy away from over-reliance on oil and gas exports. Under Emefiele, the central bank has made large sums of money available for investment in projects deemed to be strategic. These have included food-processing plants and small and medium-sized farms.

Buhari won re-election to the Nigerian presidency in February, and unexpectedly nominated Emefiele for a second five-year term as governor three months later. Buhari is a former army general who ruled Nigeria as a military dictator from 1983 to 1985.

Under his rule, the country’s finance ministry has been viewed as politically weak. Emefiele has become the most prominent figure in Nigerian economic policy-making. Under his leadership, the central bank has carried out policies that would normally have been the preserve of the finance or industry ministry.

Trump criticises ‘clueless Jay Powell’ as markets plunge

By Central Banking Newsdesk | News | 15 August 2019

US equity markets face sell off and 30-year treasuries dip below 2% for first time

US president Donald Trump attacked the Federal Reserve again, while defending his trade war, as yields on US 30-year bonds hit record lows.

On August 14, the president criticised the Fed and its “clueless” chairman Jerome Powell for not reducing rates aggressively enough as investors flocked from US equities into Treasury securities. 

“We are winning, big time, against China. Companies & jobs are fleeing. Prices to us have not gone up, and in some cases, have come down,” Trump said in a tweet. “China is not our problem, though Hong Kong is not helping. Our problem is with the Fed. Raised too much & too fast. Now too slow to cut.”

On July 31, the Fed reduced its policy rate range by 25 basis points to 2-2.25%, in response to growing downside risks in trade and the global economy.

The president’s tweet was in reaction to a turbulent morning on Wall Street. The S&P 500 closed almost 3% lower on August 14 from close a day earlier. The Down Jones was also down just over 3% during the same period.

Ten-year treasury yields fell from 1.68% at the start of the day to 1.59% at close. The yield curve closed inverted with one-month treasury yields at 1.98% and 10-year treasuries at 1.59%. The yield curve has sustained its inversion since the beginning of August.

Today (August 15), 30-year treasury yields also fell, dipping below 2% for the first time for a record low of 1.94%. On average, including treasuries at all maturities, yields have fallen roughly 9.7% since August 1. The reduction suggests investors have sought a safe haven in government-backed assets as fears over a global slowdown intensify.

“Spread is way too much as other countries say THANK YOU to clueless Jay Powell and the Federal Reserve. Germany, and many others, are playing the game! CRAZY INVERTED YIELD CURVE! We should easily be reaping big Rewards & Gains, but the Fed is holding us back,” Trump added in a further tweet.

The president’s latest remarks add to a list of previous attacks aimed at the Fed and Powell. His actions contrast sharply with those of previous US presidents, who almost always respected the Fed’s independence of the institution. It remains to be seen whether his interventions will have any impact on the Federal Open Market Committee’s (FOMC) policy-making process.

On this occasion, it appears Trump is attempting to deflect the blame of the slowing US economy onto the Fed and away from the series of tariffs he has placed on imported goods.

US GDP increased at an annual rate of 2.1% in the second quarter of this year, down from 3.1% in the first quarter. The FOMC projected growth to be 2.1% for 2019 when the last forecasts were published in June.

On August 2, the trade war escalated when Trump said he would place a 10% tariff on $300 billion of additional Chinese goods. The announcement sent the S&P 500 and the Dow Jones downwards, with a roughly 1% sell off.

On August 12, however, Trump quickly retreated from his earlier aggressive tariff announcement. He said he will delay the new tariffs, which were set to be implemented September 1, until after mid-December to avoid harming consumers heading into Christmas.