Global weekly: Central banks hold the key

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ABN AMRO Private Banking, Expertise, Investments, Treasury and special products, Forex

Risks to the global economic outlook are mounting, as financial conditions tighten and oil prices slide. Central banks have the power to break the gloom.

The horrible start to 2016 continued this week. The decline seen in equity markets and rising spreads in bond markets are largely owing to the pricing-in of a recession scenario. We believe this goes too far, although, admittedly, we are not as positive regarding the economic outlook as we were at the beginning of the year.

Central banks hold the key to improving market sentiment. They should not be counted out as having no resources left – there is still plenty of firepower in central bank arsenals. From putting prospective rate hikes on hold, shifting to more deeply negative rates to increasing quantitative easing through a broader range of asset purchases or enhanced public spending – lots of options remain. The financial crisis clearly proved that central banks can be innovative and effective in fighting destructive market forces.

So far, the missing ingredient is conviction. Federal Reserve Chair Janet Yellen reiterated her concerns this week about risks to the economy, signaling that tighter financial conditions were an issue that the Fed is watching. The Fed, however, needs to communicate more decisively that rate hikes are not in the offing until the market situation improves. The European Central Bank and Bank of Japan could also do more. Although they are clearly heading toward more monetary easing, it is not clear to the market that they will do whatever it takes to revive growth and inflation.

We think central banks will eventually deliver and that global reflation efforts will intensify. The risk is that the longer they wait, the more damage that can be done.

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