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Governor Kim Choong-soo and the South Korean central bank cut its benchmark rate Thursday. Investors were unimpressed. (KIM HONG-JI/REUTERS)
Governor Kim Choong-soo and the South Korean central bank cut its benchmark rate Thursday. Investors were unimpressed. (KIM HONG-JI/REUTERS)

Central banks ‘running out of ammunition’ to stimulate growth Add to ...

Investors are losing faith in the ability of central banks to stimulate growth amid economic setbacks.

Markets stumbled Thursday despite rate cuts by the central banks of Brazil and South Korea, and partly on disappointment by a lack of action from the U.S. Federal Reserve.

“The market is expecting them to do more,” said Charles St. Arnaud, an analyst at Nomura Securities and former Bank of Canada economist.

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Equity markets reacted with disappointment to a recent spate of central bank decisions and insight into how those decisions are made. Trading in Asia, Europe and North America was down on Thursday after news that only a few members of the Federal Open Market Committee support more stimulus spending by the Federal Reserve. Decisions from central banks in South Korea and Brazil to cut their overnight rates by half a per cent or less on Thursday appeared only to disappoint investors looking for more drastic action.

That sounds like a tall order considering central banks in major economies have recently lowered their benchmark rates. Last Thursday, the European Central Bank cut its overnight rate by a quarter of a percentage point to 0.75 per cent, and the People’s Bank of China made its second cut to its key rate in the past two months. The most recent cut reduced China’s overnight rate to 6 per cent from 6.31 per cent. Last month, the Federal Reserve opted to extend its “Operation Twist.”

For markets, this appears not to be enough. Investors are looking ahead to the prospect of a slow and messy solution to Europe’s economic problems and are worried about the approaching fiscal cliff in the United States. Weakness is spreading to countries that were previously thought to be managing well through the recovery – Australia recently reported an unexpected loss of 27,000 jobs, which all but reversed a 28,000-job gain in the previous month, and the South Korean central bank’s decision to cut its overnight rate came as a surprise.

“A lot of market participants would like to see central banks buy some protection to downside risk,” Mr. St. Arnaud said, but central banks seem unwilling or unable to do more, preferring to wait and see how these risks materialize.

In Canada, the central bank is expected to hold its benchmark rate at 1 per cent next week.

A few positive signs are shining through. Lending in Europe appears to be picking up as private bank deposits at the European Central Bank fell by more than half following the ECB’s decision to cut the deposit rate to zero to encourage lending. In the United States, weekly jobless claims fell in the most recent report, a possible indication of a pick-up in the labour market.

Investors are reflecting the “massive, widespread pessimism” that seems to have taken root in economies around the world, said Chris Ragan, associate professor of economics at McGill University and former adviser at the Bank of Canada.

Markets are asking a lot of central banks if they expect monetary stimulus alone to restore demand in the world’s troubled economies, he said.

“I do think that the problems out there are more than what just monetary policy can deal with,” he said. “It’s not enough for central banks to do the right thing.”

Minutes from the last Federal Reserve meeting, released Wednesday, suggest its policy setting group, the Federal Open Market Committee, is reluctant to unveil another round of quantitative easing, which is the stimulus measure markets appear to want. The Fed is waiting for more evidence if it is to act.

Since that doesn’t appear to be on the table, there is a sense in the markets that central banks “have done most of what they can do,” said Philippe Bergevin, a senior policy analyst at the C.D. Howe Institute. “There’s a feeling that they’re running out of ammunition.”

With short-term borrowing rates in the United States and Britain at effectively zero, monetary policy is approaching its limits to help boost the economy, Mr. Bergevin said.

Investors and central bankers alike seem to be coming to this realization. Federal Reserve chairman Ben Bernanke himself has repeatedly said that monetary policy is “no panacea,” and has urged more fiscal support from policy makers in Washington.

To be effective, any further monetary stimulus in the U.S. must be part of a package of measures that includes fiscal stimulus, Mr. Ragan said.

“If you ask yourself why the fed isn’t doing QE3, I think its partly because monetary policy in the Fed is more political than it is in other countries,” he said.

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