Summary: The expectations regarding more accommodative monetary policies in developed markets have recently found further support, with the measures against deflation being discussed more intensely. Despite the decoupling between developed and developing countries, the ultra-loose monetary policies in the former limit the central banks’ maneuvers in the latter. Therefore, many central banks choose to rely on monetary policy tools other than interest rates, such as decisions to prevent currency appreciation or macro prudential tools. Turkey also follows suit.
The news flow have continued to feed into the expectations that the Fed would start the second round of quantitative easing in November meeting and the anticipations of abundant global liquidity conditions have remained supportive of the financial markets. The FOMC minutes of the September 21st meeting was the last example. The FOMC members sounded very hopeless regarding the growth and inflation outlook, while most members favored more easing in monetary policy ‘before long’. Although the Committee members considered it unlikely that the economy would reenter a recession, many expressed concern that output growth, and the associated progress in reducing the level of unemployment, could be slow for some time. Participants noted a number of factors that were restraining growth, including low levels of household and business confidence, heightened risk aversion, and the still weak financial conditions of some households and small firms. Note that Fed has been uncomfortable with inflation being below levels consistent with the FOMC's dual mandate of maintaining full employment and price stability in the long run. While a minority in the Committee believes that additional accommodation would be warranted only if ‘the outlook worsened’ and ‘the odds of deflation increased materially’, many participants see a ‘too slow economic growth that would prevent satisfactory progress toward reducing the unemployment rate’ or ‘inflation surfacing below target levels’ as appropriate to provide additional monetary policy accommodation. In that context, a number of new alternative policy measures have been discussed at September FOMC meeting, as well. Among them ‘expanding long term bond purchases’ and ‘steps that would lift inflation expectations’ were the key focus areas. The minutes show that the members also discussed the best means to calibrate and implement additional asset purchases. Previously, we mentioned the key points of comments from New York Fed official Sack. Recall that his remarks hinted that the asset purchases would be in relatively continuous but smaller steps, rather than in infrequent but large increments.
Sack emphasized that asset purchases that would enlarge the balance sheet should be seen as a substitute for the changes in federal funds rate. The key points in Sacks speech were as follows: 1) the balance sheet should be adjusted in relatively continuous but smaller steps, rather than in infrequent but large increments. 2) The balance sheet decisions should be governed to a large extent by the evolution of the FOMC’s economic forecasts. 3) The movements in balance sheets should be stressed to have some persistency in order to make them more influential. 4) Providing information about the likely course of the balance sheet could be desirable. 5) Some flexibility should be incorporated into the program.
Last but not the least; we also want to touch on the monetary policy measures discussed by the Fed that would affect short term inflation expectations. As is known, real interest rate (that is the difference between nominal interest rates and expected inflation) is influential on total demand. Especially, the inflation expectations turn to be more important for monetary policy makers when policy rates are virtually zero. That is because; a decline in short-term inflation expectations increases short-term real interest rates, thereby damping aggregate demand. Conversely, in such circumstances, an increase in inflation expectations lowers short-term real interest rates, stimulating the economy. Therefore, Fed seems to have started mulling on alternative strategies that would lift short term inflation expectations higher, including providing more detailed information about the rates of inflation the Committee considered consistent with its dual mandate, targeting a path for the price level rather than the rate of inflation, and targeting a path for the level of nominal GDP. The last two strategies are new approaches for the central banking and there are no other countries that use them. Accordingly, these policy alternatives would unlikely be implemented in the short term.
While there are growing signs that the Fed would opt for more monetary easing, other Central Banks have also started to feel the pressure. Glancing at home, the outlook is quite mixed. The surprisingly strong industrial output in August triggered upgrades in growth forecasts, while the automotive sales and domestic demand in general have remained robust. These factors have the potential to put upward pressure on interest rates. On the other hand, the downside risk to external demand, the slowdown signals from leading economic activity indicators, TRY appreciation, the decline in bond yields and risk premiums, the impression of a tighter fiscal policy stance thanks to the Medium Term Program budget targets are all among the factors that would necessitate for lower policy rate or at least would urge for the maintenance of the current stance. The MPC meeting on October 14th was supposed to shed more light on how these developments would affect the Central Bank’s position. This meeting had an added importance since it was the last one to be held prior to the Inflation Report (where the Bank would update the inflation and output gap forecasts) due October 26th. The MPC decision did not involve much surprise and the statement indicated that the exit strategy would remain on course. After the meeting, the Central Bank also announced new decisions regarding the F/X market and open market operations. The Bank seemed to have slightly upgraded their assessment of the economic outlook in general. They said the economic activity continues to recover and domestic demand displays a relatively stronger outlook. In due course the Central Bank presumed headline inflation to be in a declining path, while core inflation was projected to remain consistent with medium term targets. From here, one may conclude that despite the decline in the core price inflation to as low as 3.7% in September, the Bank preferred to remain cautious due to the upside risks on headline CPI regarding the food price inflation. On the policy rate front, the Bank left their rhetoric untouched by reiterating that current levels would be maintained for some time and interest rate would remain low for a long period. The Bank seems to have preferred to wait for Inflation Report to describe the likely interest rate path more clearly. Meanwhile, the Bank also emphasized that the expectations of more accommodative monetary policies in developed economies which boost capital flows toward emerging markets and the accompanied decline in risk premiums, as well as the resulting appreciation of TRY and downside pressure on interest rates exacerbate upside risks to domestic demand and eventually underscore the threats against financial stability. In that concept, it is obvious that the Bank would continue relying on tools other than policy rate. The Bank continued to proceed with measures that would help normalization of the F/X, TRY and open market operations (the Bank abolished its intermediary function in the foreign exchange deposit market, ceased 3-month repo auctions, cut the O/N borrowing rates by an additional 50 bps and cancelled the provision of one-week funding to the primary dealers) and additional increase in TRY required reserve ratio should be expected soon.
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