By Simon Kennedy
Oct. 26 (Bloomberg) -- 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 worst financial crisis since the Great Depression.
A month after warning that property prices are rising “probably excessively,” Norges Bank Governor Svein Gjedrem is set to increase interest rates on Oct. 28. Reserve Bank of Australia Governor Glenn Stevens cited costlier real estate as a reason for raising rates three weeks ago.
At the Federal Reserve, officials under Chairman Ben S. Bernanke are reviewing whether recent gains in asset prices and narrowing credit spreads are justified as they try to ensure near-zero borrowing costs don’t generate future market turmoil.
The approach may herald what New York-based Morgan Stanley calls a “new era” in which central banks pay more attention to asset prices when setting monetary policy and devising regulation, broadening their focus from inflation. The shift provides a reason to purchase the currencies of Norway and Australia as they act first, while Stuart Thomson, a fund manager at Ignis Asset Management in Glasgow, says investors should be skeptical about buying into rallies in markets from stocks to commodities.
Central banks “will be very wary as property and equity prices start to boom,” Stephen Cecchetti, head of the monetary and economic unit at the Basel, Switzerland-based Bank for International Settlements, said in an interview in Bloomberg’s London office. “They will worry about it much more actively and they’ll do that around the world.”
Speculative Gains
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 speed and the danger of market excess increases, according to the Washington-based International Monetary Fund, which has 186 members. Central banks “should examine what is driving asset-price movements and be prepared to act,” the IMF said in its latest World Economic Outlook, published Oct. 1.
Fueled in part by record-low interest rates, the value of stocks worldwide has advanced 76 percent to $45.1 trillion from this year’s low on March 9. Oil passed $80 a barrel on Oct. 21 for the first time in a year, and gold reached an all-time high of $1,072 an ounce on Oct. 14.
Record Apartment Price
The average cost of a London home rose 6.5 percent this month to 416,157 pounds ($678,596), the most since records began in 2002, while Hong Kong-based Henderson Land Development Co. said it sold an apartment in the Chinese city for a world-record price of HK$439 million ($56.6 million).
“We may be planting the seeds of the next cycle of financial instability,” New York University Professor Nouriel Roubini said in an interview.
Former Fed Chairman Alan Greenspan advocated a hands-off approach to asset prices during the U.S. 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.
“There is no evidence that it works other than in computer models,” he said in a January 2008 interview about the idea that central banks should raise rates to pop asset bubbles. He noted that the stock market merely leveled off when the Fed doubled rates to 6 percent in 1994-95 and then resumed its climb.
Subprime Mortgages
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 $310 billion in 2003, according to estimates by Inside Mortgage Finance in Bethesda, Maryland.
The question now is “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,” Bank of Israel Governor Stanley Fischer said Aug. 21.
Fischer may today leave Israel’s key rate at 0.75 percent, according to the median estimate of 14 economists in a Bloomberg survey. Two months ago he became the first central banker to raise borrowing costs since the crisis began ebbing. The expectation of higher rates may threaten Israel’s position as the world’s best-performing residential-property market.
Targeting Assets
All 20 economists surveyed by Bloomberg expect the Norges Bank to raise its key 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 Sept. 30 his bank doesn’t target assets, he added equity prices and property prices must be taken into account when projecting inflation and output. House values are at the peak levels of 2007, estimates from the Finance Ministry show.
Stevens said “dwelling prices have risen appreciably” when Australia’s central bank unexpectedly increased its benchmark rate by a quarter-point on Oct. 6 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 in Brisbane.
“That is part of the general economic picture that monetary policy looks at,” Stevens said in an Oct. 15 speech. “What we try to do is build as complete a picture as possible.”
Best Performer
The shifts are luring foreign-exchange traders. Australia’s dollar was the best performer against the U.S. dollar this month through Oct. 23 among the 16 most-traded currencies. Norway’s krone ranked fourth.
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, said Spyros Andreopoulos, an economist at Morgan Stanley in London.
“At the very least, they’ll be inclined to be more vocal when uncomfortable with asset-price developments,” he said.
While policy makers, 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, said William White, Cecchetti’s predecessor at the BIS, which serves as the bank for central banks. They’re 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.
Economic Fundamentals
Some central banks are eager to see assets rise to boost their economies, said Richard Batty, global-investment strategist at Standard Life Investments Ltd. in Edinburgh. The challenge remains how to conclude when prices no longer reflect economic fundamentals and whether anything can be done about it, he said.
“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,” said Batty, who helps oversee about $200 billion. “Deciding whether an asset is cheap, fairly valued or expensive is a difficult proposition.”
When Bernanke was a Fed governor in 2002, he sided with Greenspan by saying “monetary policy cannot be directed finely enough to guide asset prices without risking severe collateral damage to the economy.” He’s now likely to maintain a preference for revamping supervision such as by enforcing stricter capital rules on large banks to curb their risk-taking and leverage. Federal Reserve Bank presidents appear divided over whether interest rates should be used.
‘Slippery Slope’
“In certain circumstances, the answer as to whether monetary policy should play a role may be a qualified yes,” Janet Yellen, of San Francisco, said in June. By contrast, Philadelphia’s Charles Plosser said in an Oct. 22 Bloomberg Radio interview that trying to identify and head off asset bubbles is a “very slippery slope” and rates are a “very blunt instrument.”
In Asia, the central banks of South Korea and India are already signaling they may boost rates next year. South Korean home prices rose for a sixth month in August, while India’s Mumbai Stock Exchange Sensitive Index is up about 75 percent since January.
“Monetary policy must not neglect asset-price movements,” Qin Xiao, chairman of China Merchants Bank Co., China’s fifth- largest bank by market value, wrote last week in the Financial Times. It is “urgent that China shifts from a loose monetary policy stance to a neutral one,” he said.
Assessing Risks
The European Central Bank is studying asset prices as it reviews what to include when monitoring developments in money and credit growth as part of an assessment of the risks to price stability.
“Experience and developments in the literature appear to support a shift in favor of the adoption of some form of leaning against the wind,” President Jean-Claude Trichet said Aug. 22, adding he doubted it could be done in a “mechanical way.”
Bank of England Chief Economist Spencer Dale said last month he favored limiting its so-called quantitative-easing plan in August because he worried that spending more than 175 billion pounds might stoke asset prices too much.
Officials are “very doubtful” monetary policy can tame credit cycles, arguing that doing so in the last boom would likely have triggered a prolonged recession, Deputy Governor Paul Tucker said Oct. 22. A forthcoming discussion paper will instead outline instruments such as tighter collateral standards and risk measures banks could adopt to make their industry more resilient, he said.
Inflation Fighting
While tackling asset increases “may undermine” inflation fighting, a central bank can bolster its credibility by adopting a price-level target, requiring it to make up for past misses in the inflation goal, says Bank of Canada Governor Mark Carney. The bank is considering whether to introduce such a strategy after 2011.
A survey of 147 clients published last week by New York- based Goldman Sachs Group Inc. found 75 percent think low rates are triggering “too strong” climbs in assets.
When central banks crack down, “financial instability” will ensue as investors gauge their pain thresholds, said Ignis’s Thomson, who helps manages about $100 billion.
“Central banks will be more inclined than they were before to look at whether asset prices have gotten out of line,” White said. “We’ve seen what happens when markets go wrong.”
To contact the reporter on this story: Simon Kennedy in Paris at skennedy4@bloomberg.net
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