12 Nov 2015
A Comparative Analysis on the Balance Sheet Adjustment Mechanisms of the Big Four Central Banks
In recent months, market participants have been fixated on when the Fed is going to raise interest rates. Regardless of when it is going to act, the Fed’s next move is likely to tighten, which is in sharp contrast to the easing stance of the European Central Bank (ECB), the Bank of Japan (BoJ), and the People’s Bank of China (PBoC). The Fed will likely decide to hike rates before contemplating when and how its huge balance sheet as a result of quantitative easing should be unwound. Meanwhile, the balance sheets of the ECB and the BoJ continue to increase steadily. By contrast, the PBoC’s balance sheet has shrunk somewhat since the beginning of the year, diverging from its main counterparts in the US, Eurozone, and Japan. This also appears to contradict with the fact that the PBoC has cut interest rates and reserve requirement ratios (RRR) for six and five times, respectively, since last year.
Divergent monetary policies among the big four central banks
The stances of monetary policy of the big four central banks are divergent in both the conventional dimension of interest rates and the unconventional dimension of balance sheets. In terms of interest rates, the Fed, the ECB, and the BOJ are virtually all at the zero bound. As for the PBoC, one-year benchmark deposit and lending rates now stand at 1.5% and 4.35%, respectively, after six rate cuts since last year. Benchmark interest rates in China still have room to fall further but are unlikely to reach the zero bound. If the Fed decides to raise rates by the end of the year, it will mark the beginning of a rate hike cycle, though probably shorter and more moderate than previous ones. As far as interest rates are concerned, the only central bank that is moving in the other direction is the Fed.
Following the implementation of zero interest rate policy, the central banks of the US, Eurozone and Japan conducted Quantitative Easing (QE) by purchasing bonds and/or other assets, in order to stimulate their economies further. The result of this policy is the expansion of these central banks’ balance sheets. Although the Fed terminated QE in October last year, its balance sheet does not shrink considerably as the Fed still reinvests its bond holding upon maturity. The Fed’s balance sheet amounted to USD 4.4862 trillion (as of 7 October), only USD 30 billion or 0.7% lower than the record high of USD 4.5161 trillion. The balance sheet contraction was mainly due to the decrease of outstanding AMBS outstanding. This should be only a temporary phenomenon during the reinvestment process, instead of an intentional reduction of the Fed’s assets. As a result, although the US’s monetary policy is neutral for the time being, the monetary environment remains at the loosest condition in history.
As for the ECB, its balance sheet amounted to EUR 2.6323 trillion (as of 9 October). Although the size was substantially below the record level of EUR 3.1022 trillion in mid-2012, the ECB did not conduct any QE at that time and just injected liquidity to the banking system through LTRO. Following the repayments of the matured LTRO loans, the ECB’s balance sheet contracted passively and its size decreased to EUR 1.9882 trillion in September 2014. Since the Eurozone economy was still struggling at that time amid the relapse of the Greek debt crisis, the ECB was determined to launch QE with the aim of expanding its balance sheet size back to the record high. Meanwhile, the BoJ took actions more directly. Its balance sheet size hit a record high of JPY 369 trillion after several rounds of QE.
The PBoC is different from other three major central banks in terms of balance sheet adjustment. Its balance sheet expanded 1.7 times since 2006 and reached RMB 34.5411 trillion in February this year (the size was even larger than the Fed’s balance sheet after converted into USD). Its balance sheet size then started to shrink and reached RMB 32.6039 trillion in September, a decrease of RMB 1.9372 trillion or 5.6%. On one hand, the PBoC has already cut interest rates and RRR by six times and five times, respectively. On the other hand, its balance sheet size still contracted. The trend of the PBoC’s balance sheet size is different from other three major central banks and even appears to contradict with the central bank’s own policy stance.
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