Executives should monitor central bank pronouncements

by: Issues: May / June 2012. Tags: Leadership. Categories: Leadership and Viewpoint.

The task of divining the economy’s direction may confound managers, but monitoring the pronouncements of the institutions responsible for monetary policy is in itself a policy that makes the job less taxing.

Knowing the direction in which the economy is headed is an important input into many executive decisions.  It may not be the most exciting reading, but executives looking for insight into the economy should be monitoring the pronouncements of the world’s major central banks.  They may not like what they see.  The next couple of years are likely to be a challenge.

Economic prospects affect business in a number of ways.  Decisions to invest in product, inventories, receivables, promotion, plant, equipment, machinery, research and development are very dependent on the economic outlook.  So are human resource decisions involving hiring, layoff, compensation and collective agreement length.  On the finance side, you get more comfortable adding debt to the balance sheet and paying dividends as the economic prospects brighten.  Acquisition policy is similarly tied to economic prospects.  The old adage that a rising tide lifts all boats and vice versa applies to most things a business does.  The economic equivalent of a rising tide is a prospering economy.

Central banks are a gold mine of information.  They speak through press releases surrounding policy rate announcements, periodic reports, and the testimony and speeches of their senior officials, including their governors and chairmen.  Executives will find all useful reading but they should particularly diarize the policy-rate press releases.

Since central banks so influence interest rates through their policy rates, and since interest rates are so key to the economy, the policy rate views of central banks are of considerable importance.  The Bank of Canada’s policy rate is the overnight rate; the Federal Reserve’s policy rate is the federal funds rate.

The Bank of Canada is not bullish.  Its March 8, 2012 press release maintaining its overnight rate stance is clear:  “The global economy is still expected to grow below its trend rate as the deleveraging process in advanced economies proceeds …  Recent developments suggest that the outlook for the Canadian economy is marginally improved from the January Monetary Policy Report.  Although the economy will likely grow faster than forecast in the first quarter due to temporary factors, underlying economic momentum remains around trend, balancing domestic strength and external weakness.  Private demand is now expected to be slightly stronger than projected, owing to improved sentiment and highly-supportive financial conditions.  Canadian household spending is expected to remain high relative to GDP as households add to their debt burden, which remains the biggest domestic risk.  Net exports have been supported by stronger – than anticipated U.S. activity but are expected to contribute little to growth, reflecting still – moderate foreign demand and on-going competitiveness challenges, including the persistent strength of the Canadian dollar …  Reflecting all of these factors, the Bank has decided to maintain the target for the overnight rate at one percent.  With the target interest rate near historic lows and the financial system functioning well, there is considerable monetary policy stimulus in Canada.”

Now consider the United States.  With exports responsible for 25 percent of the Canadian economy and with 75 percent of those exports going to the U.S., where the U.S. economy goes is very much a question of where we go.  Add to that the virtual integration of capital markets across North America and high employing manufacturing industries like car-and-truck assembly and it is the wise Canadian executive who keeps a close eye on the U.S. economy.  The Bank of Canada and the Federal Reserve are the key central banks for Canadian executives.

Consider this statement from the March 13, 2012 press release of the Federal Reserve, which maintains its federal funds rate stance:  “Information received since the Federal Open Market Committee met in January suggests that the economy has been expanding moderately…  The Committee expects moderate economic growth over coming quarters and consequently anticipates that the unemployment rate will decline gradually towards levels that the Committee judges to be consistent with its dual mandate.  Strains in global financial markets have eased, though they continue to pose significant downside risks to the economic outlook.  The recent increase in oil and gasoline prices will push up inflation temporarily, but the Committee anticipates that subsequently inflation will run at or below the rate that it judges most consistent with its dual mandate.  To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy.  In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to .25 percent and currently anticipates that economic conditions – including low rates of resource utilization and a subdued outlook for inflation over the medium run – are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.”

The Bank of England, the European Central Bank and the Bank of Japan have their own well-known struggles.  Emerging economies like China, India and Brazil are more promising, but certainly not robust.

So what should Canadian executives take from the musings of central banks?

First, economic growth in Canada is not going to be anything to write home about for the next couple of years.  The Bank of Canada’s point about domestic strength driven, in part, by target interest rates near historic lows balanced against external weakness is compelling.  Even more compelling is the Federal Reserve’s view that exceptionally low federal-funds rate levels will be necessary through at least late 2014.  Signaling U.S. rates at historic lows for so long basically tells Canadian executives everything they really need to know.

Second, slow growth equates to pressure on federal, provincial and municipal government finances that are already feeling strain from the stimulus associated with the 2008 financial crisis and accompanying recession.

Third, job creation is going to be slower than desirable and probably insufficient to accommodate all new labour-force entrants.  Weak economic growth assures weak private-sector job creation, and public-sector job creation will be constrained by the need to restore government finances.

Fourth, under normal circumstances, the good news in a slow-growth economy is benign inflation.  That is a good bet but by no means a sure thing, given pressures on inflation from energy prices, food prices and deficit-driven rising taxes.

Central banks, of course, do not tell executives what to do, but in the current slow-growth case it is obvious:  above all run a good business; keep present customers and attract new ones; keep the product competitive; relentlessly control costs; be careful about adding debt; maintain good relations with employees; maintain good relations with bankers and other sources of funds; plan continually.  Very straightforward stuff that is much easier said than done!  But well worth it!

The business of central banks is the application of monetary policy to the end of producing desirable outcomes for the economy.  For central banks, it all begins with judgments about the emerging economy.  Central banks like the Bank of Canada and the Federal Reserve are very good at what they do.  They spend a lot of time explaining their thinking.  Executives should understand and take advantage.