Index > COVID-2019
Back
Thursday, February 27, 2020
Central Banks Worldwide Turn to Low Interest Rate Policy Amidst Covid-19 Cocerns
ANBOUND

The global outbreak of the novel coronavirus (COVID-19) epidemic has threatened the international capital market. Even though the impact of the outbreak is believed to be short-term, the areas it has impacted, and the extent that the virus has spread to remains unknown. Judging by the global market's recent reaction, the uncertainty surrounding the epidemic's development has led international capitals to be hedged, as evident by global major capital markets such as Europe and the United States who have entered a "hedging" mode. Going by that, it is clear that the impact the outbreak has towards the global economic is about to get a lot worse. According to the researchers at ANBOUND, the impact, particularly towards the financial market will hasten the formation of low-interest rate international currencies around the world.

In fact, ANBOUND has noticed that low-interest rate international currencies have been forming since last year. Under the monetary easing policy from the European Central Bank and the Bank of Japan, the level of interest rate for both Europe (-0.5%) and Japan (-0.1%) were negative. On the other hand, the Federal Reserve System (Fed) in the United States has reduced the interest rates and the policy rates for several times. The benchmark interest rate set by Fed is between 1.50% - 1.75%, where if the inflation rate is taken into consideration, the actual interest rate will be negative too. This has caused the global monetary systems to weaken and interest rates to be lowered. Put simply, this means that the state of the monetary environments correlates with the level of economic growth in each economy entity.

Unfortunately, the impacts brought by the epidemic have caused the market rates to decline a step further, resulting in more growing concerns that central banks will be cutting their interest rates. For the time being, the yield on the benchmark 10-year treasury has fallen to a record low of 1.302%, while the yield on 30-year treasury has fallen to 1.807%. Also, on the 26th, the yield on 2-year treasury reached the low point of 1.136%, the lowest level since February 2017. The market predicts there is an 85% probability for the Fed to reduce the interest rate in July, compared to its earlier prediction of 50% in February. By March, the probability has since increased to 60%. In Europe, "hedged" transactions have caused a reduction in the German government bond yield; though it had an inverse effect on Italy's yield. The yield on 10-year German bond is -0.50%, on par with the European Central Bank's deposit interest rate. Subsequently, Germany's entire yield curve has dipped below a negative range again. Meanwhile, the euro area inflation rate, which is measured in terms of 5 years / 5 years swap-rate has fallen further, approaching a low point since early October 2019. This means that the European Central Bank's probability of reducing its interest rate by 10bps in July has gone up to 50%, from 35% a week ago. Even in the case of China, liquidity policy injected by the central bank has caused the 10-year government bond yield to drop below 3% in February.

The changes in the capital market and the difficulties posed to the real economy by the epidemic are driving monetary policy makers to further implement easing policy, which will in turn intensify the current international liquidity easing and excess. As a matter of fact, during the recent G20 Finance Minister Meeting, several economy entities including the Bank of Japan, the European Central Bank have expressed that they will push for monetary and financial easing policy to maintain the country's economic growth and achieve the monetary policy's objectives. While the Federal Reserve would like to maintain the same monetary policy, they mentioned that they will continue to keep an eye on the epidemic's impact. If there is no improvement in the U.S. inflation rate, further rate cuts can be expected. As ANBOUND had mentioned before, this would mean that the future easing of the international currency will not have any backspin effect and continuous liquidity injection can cause the state of currencies to expand with low interest rate, zero interest rate or even negative interest rate.

Of course, there will always be disputes regarding the impacts of low interest rates and negative interest rates, both theoretically and in applied scenarios. The current governor of the Bank of Japan, Haruhiko Kuroda admits that large scale stimulus policies did not achieve its goal of 2% inflation rate. Some central banks in European countries have also complained about the pressure in the banking sector due to the implementation of negative interest rate policies. Concurrently, many regulators and investors are extremely worried about the expansion of the capital market bubble brought by the monetary environment under the effects of a low interest rate. The outcome in Japan and Europe has clearly shown that low interest rate policies and environment do not lead to an economic recovery, and instead have caused the Japanese and European economic to hover around zero growth for a long time. Likewise in China, many people are wary and pessimistic about a monetary environment with low interest rates. Former deputy governor of the People's Bank of China, Chu Min has recently expressed that low interest rate has caused low inflation and low growth. He believes that if the world economy is experiencing low interest rate and loose monetary, it will cause the global economy to experience a decline, and such an outcome might take place in the three or four years to come. The Deputy Governor of the People's Bank of China, Chen Yulu also pointed out that China should treasure the current space of normal monetary policy and be on alert of the risk of low interest rates.

Still, ANBOUND pointed out that there is a significant relationship between low interest rate and low inflation together with global oversupply and the intensifying of economic virtualization. Changes in the economic structure, urbanization and shaving implemented by the central banks will cause excess capital, which will in turn offset the negative effect of low interest rates. Particularly, the implementation of low interest rate and negative interest rate following the financial crisis will play an extremely important role in maintaining economic growth long term. The former president of Fed, Janet Louise Yellen has recently admitted that the policy implemented by Fed to the U.S. economy has brought a positive effect to the growth during crisis. Hence, it is said that low interest rate policy is a strong remedy for financial crisis, and that the current epidemic can be considered a crisis to some extent. Thus, low interest rate is a realistic choice that should be taken into consideration by countries. That being said, there will always be disputes on monetary easing policies and doubts on monetary environment with low interest rate, especially considering the situation, though from the viewpoint of the central banks and the market, the epidemic outbreak will definitely hasten the formation of such environment.

Final analysis conclusion:

ANBOUND has predicted that China will soon enter a state of international currency with low as well as zero interest rate and it seems that is likely to come true given the current state of the outbreak. The impacts may cause the Chinese economy to undergo a currency devaluation, which means the Chinese monetary policy and financial market may require an adjustment, either through active or passive means.

Copyright © 2012-2024 ANBOUND