The Era of Easy Monetary Policy… Extended!

Downbeat global economic forecasts have led several major central banks to go easy on their hawkish biases and push back rate hike expectations. What might this extended period of easy monetary policy mean for risk-taking?

For the newbies out there who are still struggling to make sense of how monetary policy could affect forex price action, here’s a quick refresher. You see, central banks typically use monetary policy tools such as interest rates or money supply in order to maintain price stability or to control economic activity. A strengthening economy could require policy tightening to keep inflation in check while weak economic performance could warrant policy easing to boost lending and spending.

While monetary policy easing or expectations of such tend to spark risk-off moves or currency deprecation for a while, it could eventually spur currency appreciation and risk-taking when the economy starts to recover. After all, an extended period of low interest rates (Sound familiar?) winds up encouraging businesses and consumers to take advantage of cheaper loan rates to expand their operations or make big-ticket purchases. This could translate to a pickup in production, hiring, shopping – you name it! In effect, these contribute to stronger growth and more upbeat economic prospects.

With that, it’s no wonder that the possibility of prolonged easy monetary policy sometimes leads to risk rallies, which are particularly evident in the equity markets. Back in June, when Fed head Yellen acknowledged U.S. economic improvements while pledging to keep rates low for the time being, risk appetite surged as the S&P 500 reached new highs while the Nasdaq marked consecutive daily gains. That’s because the U.S. central bank just confirmed that economic stimulus will stay in place even as progress has been made, which could be another way of saying that things are likely to keep getting better!

While improving economic data has led forex market participants to entertain the idea of seeing policy tightening soon, the possibility of extending the era of easy monetary policy has been raised once more.

As Forex Ninja mentioned in his article on Why Forex Trends Could Pause in Q4 2014, the BOE and the Fed are backpedaling on their rate hike forecasts for next year. Just last week, BOE chief economist Andy Haldane confirmed that a rate hike might take place later than expected while Fed official Bullard even recommended that the U.S. central bank should consider delaying the end of its taper program. Apart from that, the prospect of additional BOJ stimulus isn’t completely off the table yet while the ECB is mulling further easing measures in an attempt to keep the euro zone economy afloat.

It’s too early to tell whether the global economy is just stuck in a rut or if a major meltdown is just waiting around the corner, but it’s pretty clear that central banks are not looking to withdraw stimulus anytime soon. This could keep businesses and consumers confident that economic support will stay in place for the foreseeable future, which might be enough to whet risk appetite once the recovery shows traction. The question is: Is this bound to happen anytime soon?