Bubble fears make central banks watch asset prices
October 29, 2009
By Simon Kennedy
Central bankers from Washington to Oslo are taking greater account of accelerating asset prices to avoid the policy mistakes that inflated two speculative bubbles in a decade and led to the financial crisis.
A month after warning that property prices were rising "probably excessively", Norges Bank governor Svein Gjedrem is expected to increase interest rates this week. Reserve Bank of Australia governor Glenn Stevens cited costlier property as a reason for raising rates three weeks ago.
At the US Federal Reserve, officials under chairman Ben Bernanke are reviewing whether recent gains in asset prices and narrowing credit spreads are justified as they try to ensure the near-zero borrowing costs don't generate future market turmoil.
The approach may herald what Morgan Stanley calls a "new era" in which central banks pay more attention to asset prices when setting monetary policy, broadening their focus from inflation.
The shift provides a reason to purchase the currencies of Norway and Australia as they act first.
Stuart Thomson, a fund manager at Ignis Asset Management, says investors should be sceptical about buying into rallies in markets from stocks to commodities.
Stephen Cecchetti, the head of the monetary and economic unit at Bank for International Settlements (BIS), says central banks "will be very wary as property and equity prices start to boom".
Any effort to restrain assets would be aimed at avoiding a recurrence of the last two economic cycles, when low interest rates and lax regulation helped generate the boom and then bust in technology stocks and housing markets.
Deciding when or whether to take steps is increasingly important as global growth picks up and the danger of market excess rises, according to the International Monetary Fund (IMF). Central banks "should examine what is driving asset price movements and be prepared to act," the IMF said in its latest World Economic Outlook.
Fuelled in part by record low interest rates, the value of stocks globally has risen 76 percent to $45.1 trillion (R343.8 trillion) from this year's low on March 9. Oil passed $80 a barrel last week for the first time in a year, and gold reached an all-time high of $1 072 an ounce on October 14.
The average cost of a London home rose 6.5 percent this month to £416 157 (R5.31 million), the most since such records began in 2002. Hong Kong-based Henderson Land Development said this month it sold an apartment in Hong Kong city for a world record price of HK$439m (R432m).
Former Fed chairman Alan Greenspan advocated a hands-off approach to asset prices during the US expansion that lasted six years until December 2007. He said it was easier to clean up the mess of a bust than to spot bubbles and that monetary policy was too blunt to deflate them.
Greenspan's Fed kept the overnight lending rate at 1 percent for 12 months starting June 2003 and then raised rates slowly, fostering an environment in which subprime mortgage originations almost doubled to $600 billion in 2006 from $310bn in 2003, according to estimates by Inside Mortgage Finance.
Bank of Israel governor Stanley Fischer said in August that the question now was "whether the interest rate should respond to asset prices and the financial situation more generally, and there is a strong argument that the answer is yes".
Fischer left Israel's key rate at 0.75 percent on Monday. Two months ago he became the first central banker to raise borrowing costs since the crisis began ebbing.
All 20 economists surveyed by Bloomberg expect Norges Bank to raise its interest rate this week, with 19 predicting it will go up to 1.5 percent from a record low of 1.25 percent. While Gjedrem said last month that the Norwegian central bank did not target assets, he added that equity prices and property prices must be taken into account when projecting inflation and output. House values are at the peak levels of 2007, Finance Ministry estimates show.
On October 6 Stevens said "dwelling prices have risen appreciably" when Australia's central bank unexpectedly increased its benchmark rate by 25 basis points to 3.25 percent from a 49-year low and indicated further gains to come. House prices climbed 7.9 percent this year through August, according to property monitoring company RP Data Rismark.
Norway and Australia may be a "harbinger" for foreign counterparts, even if they face the dilemma of choosing between lifting rates and stalling a recovery or delaying an increase and letting asset prices spiral, says Spyros Andreopoulos, an economist at Morgan Stanley.
"At the very least, they'll be inclined to be more vocal when uncomfortable with asset price developments," he said.
While policymakers, including Bernanke, oppose specific targets for assets, they may be more willing to raise rates if markets begin to signal there is too much liquidity, says William White, Cecchetti's predecessor at the BIS, which serves as the bank for central banks.
They are also looking to back tougher regulation by curbing leverage and pursuing so-called macro-prudential supervision to constrain lending excesses and monitor economic risks instead of focusing on individual banks.
Some central banks are eager to see assets rise to boost their economies, says Richard Batty, a global investment strategist at Standard Life Investments. The challenge remains how to conclude when prices no longer reflect economic fundamentals and whether anything can be done about it, he says.
"The major central banks will need to keep policy loose for some time, so it's premature to start worrying about what to do with asset prices," says Batty. "Deciding whether an asset is cheap, fairly valued or expensive is a difficult proposition."
"In certain circumstances, the answer as to whether monetary policy should play a role may be a qualified yes," Janet Yellen, the president of the Federal Reserve Bank of San Francisco, said in June.
By contrast, Philadelphia Fed president Charles Plosser said that trying to identify and head off asset bubbles was a "very slippery slope". - Bloomberg
|
|
