Hellenic Business

Japan Follows U.S. and Europe in Stimulus Moves; Other Actions Expected -

Massive injections of stimulus into financial markets by the world's largest central banks are creating a domino effect around the globe, prompting governments from Brazil to Turkey to take steps to keep easy money from flooding in and driving up their currencies.

The Bank of Japan Wednesday became the latest central bank to ease monetary policy. That follows bold pledges by the world's two biggest central banks to launch open-ended programs to bolster their economies.

The BOJ's efforts were largely designed to stimulate Japan's moribund economy, in part by adding money to financial markets as well as driving down the value of the yen to help the nation's exporters. The bank increased the size of its asset-purchase program to 80 trillion yen ($1 trillion) from 70 trillion yen, and extended the program by six months until the end of 2013.

The European Central Bank said earlier this month that it is prepared to buy debt from euro-zone countries that need help in controlling their borrowing costs. The Federal Reserve last week announced a program to buy $40 billion a month in mortgage-backed securities until the economy recovers. Many investors expect the Bank of England to announce its own additional measures to stimulate growth.

Amid the flurry of news from central banks, financial markets have been buoyant but calm. Investors note that stocks and other riskier investments staged big rallies over the summer in part on expectations for easier monetary policy, muting the response to the news. The Standard & Poor's 500 stock index is up 1.7% since last Wednesday, the day before the Fed announced its latest easing.

Given the apparent slowing in the global economy, worries about inflation or asset-price bubbles from central bank efforts to pump money into the financial system have for the most part been pushed to the back burner. But should economic activity pick up, those concerns could quickly revive, especially when it comes to commodities or higher-yielding investments.

And, given that the Fed and other major central banks appear committed to long periods of easy money, investors expect the effects of their actions to play out for months or years.

The efforts of the world's major central banks to stimulate growth in their own economies are already rippling across financial markets.

Investors are flocking to countries and assets that offer higher interest rates than the rock-bottom rates offered in Japan, the U.S. and parts of Europe. That is driving other central banks to employ their own measures, in part to keep their interest rates low or to make their currencies less attractive.

A weaker currency makes a country's exports more affordable overseas. At the same time, that makes other nations' exports more expensive. The dynamic raises the incentive for policy makers to devalue their own currencies to remain competitive in global markets.

As with past episodes of aggressive easing by the world's major, developed-market central banks, many investors are homing in on emerging markets offering higher yields and generally healthier economies. The Brazilian real initially jumped 0.7% after the Fed's move, but finished Wednesday's session up 0.3% from a week earlier. The Mexican peso, meanwhile, has gained 2.7% over the past week, the Polish zloty is up 4.3% and the Korean won is up 1.6%.

"All of this cash generated by the Federal Reserve is going to be entering foreign shores," said Komal Sri-Kumar, chief global strategist at TCW. "Emerging markets are going to be tempted to cut interest rates…to offset their currencies appreciating too much."

Brazil took steps Monday to prevent potential waves from the Fed's easing from lifting the value of its currency, conducting so-called "reverse dollar swaps" to prevent its currency, the real, from appreciating. Also Monday, Peru adjusted its intervention strategy toward weakening the Peruvian sol, and on Tuesday Turkey cut interest rates by more than expected.

Unlike past easing episodes that created fears of a "currency war" over tidal waves of money heading toward emerging markets, some in the markets expect a muted response this time.

Officials in South Korea, Thailand, Singapore and the Philippines took a cautious view of the uptick in their currencies following the Fed's announcement, though they all asserted a readiness to smooth out market movement if capital inflows become excessive.

Investors like Alessio de Longis, a portfolio manager at Oppenheimer Funds, which has $182 billion under management, have been buying currencies of countries such as Poland, Norway, Mexico and Canada, whose central banks are seen as less likely to act to push down their currencies against the U.S. dollar.

In the previous round of Fed quantitative easing, the dollar weakened significantly against most currencies. The Wall Street Journal Dollar Index, a measure of the dollar's value against a basket of major currencies, fell 18% in the 13 months from June 2010, when expectations of more Fed stimulus first began to rise, until the $600 billion bond-buying program ended the following summer. The index dropped 20% against the Brazilian real over the same period and 18% versus the Korean won.

The dollar's decline was less pronounced ahead of the announcement last week. The WSJ Dollar Index is down 6% from its 2012 high reached in July.

The current environment is far different from late 2010, when the Fed launched its second major bond-buying program, known as QE2. At the time, the stronger growth in emerging-market nations helped attract investors from advanced economies. The Fed's move spurred loud complaints from Brazil, China and other emerging powers that a surge in "hot money" would destabilize their economies and spur unwanted inflation.

By contrast, U.S. job creation has slowed sharply since the start of the year. The euro zone is already in recession, driven by worsening downturns in southern European nations such as Spain and Italy spreading to their northern neighbors. Most emerging-market economies, in turn, have seen their export sectors struggle as a result of Europe's woes. Almost every major economy in the world is seeing its manufacturing sector contract, according to recent surveys of purchasing managers.

Recent reviews by the International Monetary Fund of the effects of QE2 dismissed many of the concerns that were originally raised about the Fed's bond-buying program.

"The Brazilians and the Chinese, who were among the biggest critics of QE2, I think have changed their view of it in hindsight," said Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics and former Fed economist. "They're just less inclined to worry about it."

Emerging-market nations are less likely to complain this time, after taking their own measures to boost exports.

China may limit the appreciation of its currency, despite appeals from the U.S. to let the yuan rise, but the country "won't risk outright confrontation with Washington in the run-up to the election," said Simon Evenett, an economist at the University of St. Gallen in Switzerland. And Brazil "lost a lot of credibility" already by devaluing its currency, the real, he said.

The Wall Street Journal