We have written before about the return of safe havens and the growing clouds of doubts around the continuing efficacy of central bank policy below the zero bound, but it certainly has more heft when a member of the central banks’ central bank says it.
In prepared remarks Claudio Borio, Head of the Monetary and Economic Department at the BIS said: “The latest turbulence has hammered home the message that central banks have been overburdened for far too long post-crisis, even as fiscal space has been dwindling and structural measures lacking.
“Despite exceptionally easy monetary conditions, in key jurisdictions growth has been disappointing and inflation has remained stubbornly low. Market participants have taken notice. And their confidence in central banks’ healing powers has – probably for the first time – been faltering. Policymakers too would do well to take notice.”
Part of the problem is that that the move to negative rates contains within it an inherent contradiction.
As the BIS points out in its latest quarterly report: “If negative policy rates do not feed into lending rates for households and firms, they largely lose their rationale. On the other hand, if negative policy rates are transmitted to lending rates for firms and households, then there will be knock-on effects on bank profitability unless negative rates are also imposed on deposits, raising questions as to the stability of the retail deposit base.”
As a result, the BIS points out, either outcome leads to further questioning of the viability of banks’ business models, which is bound to set teeth on edge.
But, there is perhaps a broader issue at stake and that is market confidence more generally and in particular, a belief in the recovery itself. ECB governor Mario Draghi has surprised markets before and there is every chance that he might do so again on Thursday. But, even his power to surprise is only as strong as the market’s belief in the efficacy of the policies the ECB chooses to follow. And, if that is beginning to shift, the risk of policy error is magnified.