The world's key central banks will not need to start raising policy interest rates until late 2010 due to low inflation and economic slack, and can then proceed gradually, the OECD said in a report published on Thursday.
The Organization for Economic Co-operation and Development said it was assuming the first moves would come near the end of 2010 from the U.S. Federal Reserve and European Central Bank, with the Bank of England following suit in 2011.
Given continued slack, close-to-zero interest rates are appropriate in most OECD countries until the latter half of 2010 and in Japan to beyond the projection period (2010-2011), the OECD said in its latest Economic Outlook.
Given low levels of inflation, policy interest rates would only need to reach neutrality by the time that upward pressures on inflation emerge, said the report.
It is likely there will be some overlap between withdrawal of unconventional monetary policy measures and the rise in interest rates, the OECD said.
In an interview with Reuters, OECD chief economist Jorgen Elmeskov said the references to late 2010 could be read as meaning the fourth quarter of 2010.
Japan, struggling with deflation, should consider more quantitative easing in the form of purchases of government bonds, the OECD said.
In Europe, the OECD suggested that the ECB should consider something clearer than non-renewal of certain financing operations as a way of normalizing monetary policy.
The ECB may have to smooth the exit from some programs where their simple non-renewal would result in a very abrupt shrinkage of liquidity, it said.
Speaking generally, it said it was vital to have clear road maps for withdrawal of unconventional measures so that markets did not misinterpret the process.
Following are verbatim abstracts from the report covering the main assumptions and recommendations on monetary policy, fiscal policy, imbalances and currency and commodity price assumptions of macro forecasts in November 19 Economic Outlook:
ASSUMPTIONS IN ECONOMIC OUTLOOK FORECASTS:
*In the United States, the target federal funds rate is assumed to remain constant at 1/4 per cent until close to the end of 2010 as there is substantial slack in the economy. Subsequently, the rate is tightened, reaching 2-1/4 per cent by the end of 2011.
* In the euro area, the main policy rate is assumed to remain unchanged until close to the end of 2010, before rising to 2 per cent by the end of the projection horizon.
Overnight rates are assumed to converge smoothly to the main refinancing rate, starting in the second half of 2010.
* In Japan, the short-term policy interest rate is assumed to remain at 10 basis points for the projection horizon, as consumer prices continue to fall
GENERAL COMMENTS ON MONETARY POLICY:
* Low inflation and large negative output gaps call for waiting until the recovery is well underway before starting to normalize policy interest rates in the United States, the euro area, the United Kingdom and Canada.
The first increases should occur in these countries only well into 2010, and the pace of normalization should remain gradual.
In Japan, ongoing deflation calls for keeping policy interest rates close to zero until inflation is positive.
*In tandem with conventional interest rate cuts, monetary authorities have implemented a wide range of unconventional measures.
As a result, the size of central banks. balance sheets has increased massively since the onset of the crisis (Figure 1.13). As financial markets normalize and economic recovery takes hold, leading to reduced liquidity preference, these unconventional measures will need to be scaled back gradually or offset, as abundant liquidity could affect inflation expectations adversely and eventually distort the functioning of financial markets.
Similarly, to avoid distortions, credit easing measures need to be tapered off gradually as credit markets return to normal.
(In United States) The Federal Reserve and the Administration must begin to withdraw the economic support as economic growth becomes self-sustaining.
(In euro zone) Low core inflation, tight credit conditions and a persistent negative output gap make it appropriate for the current expansionary monetary policy stance to be maintained until late 2010. Thereafter, emergency credit support measures should be withdrawn and policy rates gradually increased
(In UK) While monetary policy should remain expansionary over the projection period, normalization of interest rates will probably need to start in 2011.
(In Japan) The Bank of Japan should fight deflation through a strong commitment to keep interest rates at their very low current levels and to implement quantitative measures effectively until underlying inflation is firmly positive
Greater use of quantitative measures, notably the central bank's outright purchases of government bonds, may help by providing more liquidity to the market and pushing up expected inflation out of deflationary territory.
(In Canada) The Bank of Canada should hold the policy rate at its current near-zero level until the end of June 2010, as it has committed, and probably beyond
In China, where the authorities have started normalizing the pace of credit expansion, credit conditions may need to be tightened to prevent the emergence of inflationary pressures and asset bubbles if the money and credit boost this year has a bigger than expected impact on demand.
COMMENT ON IMBALANCES AND EXCHANGE RATES:
International imbalances, notably the US deficit and the China surplus, have narrowed appreciably during the downturn. The projections imply that this adjustment has now run its course. With imbalances remaining at levels that would have been unprecedented just a few years ago, the risk of disorderly exchange rate adjustment cannot be excluded.
COMMENT ON BANKING SECTOR CLEANUP:
In order to reduce uncertainty, and thus facilitate recapitalization, pressure must be maintained on banks to write down the value of problem assets on their balance sheets or to sell such assets to public or private asset management companies, with corresponding capital increases
COMMENTS ON FISCAL CONSOLIDATION:
Government budgets have suffered badly from the crisis and gross debt could exceed GDP on average in the OECD by 2011. Stopping the rot is clearly necessary and will call for fiscal consolidation that is substantial in most cases and drastic in some. That said, and countries facing acute pressures aside, consolidation should not proceed at a pace that undermines the recovery. It is worth keeping in mind that with simultaneous fiscal consolidation across countries, activity will be affected not only by domestic consolidation but also, via trade linkages, by consolidation abroad. As well, with policy interest rates in many countries set to remain low for quite some time to come monetary policy will have little room to accommodate fiscal consolidation.
FX, OIL PRICE ASSUMPTIONS AND CUTOFF DATE:
*The projections assume unchanged exchange rates from those prevailing on 26 October 2009, at $1 equals to ¥92.08, euro 0.67 (or equivalently, euro 1 equals $1.49) and CNY 6.83.
*Over the projection period the price for a barrel of Brent crude is assumed to be at a level close to $77.
*Non-oil commodity prices are assumed to stabilize around current levels.
*The cut-off date for information used in the projections is 16 November 2009. Details of assumptions for individual countries are provided in Chapters 3 and 4. (Editing by Andy Bruce)