SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Bank of Finland Bulletin 4/2011 Monetary policy and the global economy Governor Erkki Liikanen 19 September

SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND

Bank of Finland Bulletin 4/2011

Monetary policy and the global economy

Governor

Erkki Liikanen

19 September 2011

1


Themes

Global economic outlook weakened– Bank of Finland growth forecast for world economy revised

downwards– Risks of even weaker developments heightened

New phase in sovereign debt crisis– Countries’ own measures necessary but no longer sufficient

Confidence in financial institutions weakened– Demand for central bank credit increased again

Addressing uncertainty is pivotal

2


Global economic outlook weakened:

forecast backround

3


Market expectations of growth weakened

0

20

40

60

80

100

120

140

160

180

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

2005 2006 2007 2008 2009 2010 2011

USA: 20-year bond yield Euro area: 20-year bond yield

USA: S&P 500 (rhs) Euro area: DJ euro, broad (rhs)

% 3 Jan 2005 = 100

Euro area real rate: real rate on French government bond.Source: Bloomberg.24114@Chart1 (2)

Share prices and real long-term interest rates

4


Safe haven cosiderations also important

Safe haven instruments Risky instruments

0

1

2

3

4

5

6

2005 2006 2007 2008 2009 2010 2011

USA Germany Japan Switzerland

%

Source: Bloomberg.25107@10v. nimelliskorkoja(2)

Yield on 10-year government bonds

0

5

10

15

20

25

2008 2009 2010 2011

Greece Italy Ireland Portugal Spain Finland

% points

Ca 10-year government bond yield differential vs. Germany.Source: Bloomberg.25200@Spredit (enET)

Interest rate differentials in euro area

5


Confidence indicators weakened

Manufacturing, spring Consumers, end of summer

25

30

35

40

45

50

55

60

65

2006 2007 2008 2009 2010 2011

USA Euro area Japan China Brazil

Balance

Lähde: Bloomberg.25200@PMI_teollisuus (enET)

PMI: manufacturing

-40

-35

-30

-25

-20

-15

-10

-5

0

20

30

40

50

60

70

80

90

100

2006 2007 2008 2009 2010 2011

USA Japan Euro area (rhs) United Kingdom (rhs)

Balance Balance

Source: Bloomberg.25200@Chart87 (enET)

Consumer confidence indicator

6


New phase in sovereign debt crisis

Previously concerned only individual countries – Greece, Ireland, Portugal

Problems in all major developed economic areas– Annual deficits elsewhere even greater than in the euro area

Confidence weakened broadly during summer– US debt ceiling negotiations– European crisis management systems

7


Phases of the sovereign debt crisis

8


Global economic outlook weakened:

Bank of Finland forecast

9


What are the consequences of the confidence crisis for global economic growth?

Market indicator changes comparable to situation at end of spring 2010, some comparable even to the previous crisis

Uncertainty is already reflected in real economy

The longer uncertainty prevails, the greater the implications

10


Channels for spread of crisis of confidence to real economy

Uncertainty leads to defensive behaviour– More saving, consumption and investment both suffer– Global interdependencies increase the repercussions

Financing more costly and harder to get– Equity finance more costly– Longer-term debt finance also more costly Investments not made on the basis of bank loans

Market-indicator-based probability of European banking crisis has risen– At worst, rumours become self-fulfilling

11


GDP in major economic areas

60

80

100

120

140

160

180

200

96

98

100

102

104

106

108

110

2005 2006 2007 2008 2009 2010 2011

USA EU20 Japan China (rhs) Brazil (rhs)

2005/I = 100 2005/I = 100

EU20 = Euro area, United Kingdom, Sweden and Denmark.Sources: National statistical authorities, ECB, Bloomberg ja Bank of Finland.25200@BKT_taso_EU20 (enET)

GDP

12


GDP 2010 2011f 2012f 2013fUSA 3,0 1,5 1,9 2,6

(2,8) (2,7) (2,9) (3,0)EU20 1,7 1,6 0,9 1,7

(1,7) (1,3) (1,6) (1,8)Japan 4.0 -0,6 2,4 1,3

(4,4) (1,1) (1,2) (1,3)China 10,3 9,0 8,0 8,0

(10,0) (9,0) (8,0) (8,0)Russia 4,0 4,4 4,4 3,6

(4,5) (5,4) (4,7) (4,1)World 5,2 3,9 3,6 4.0

(5,0) (4,2) (4,1) (4,2)World trade 13,5 6,2 6,1 7,1

(13,6) (7,6) (7,1) (7,3)

% change on previous year (previous forecast).EU20 = Euro area, Sweden, Denmark and United KingdomSource: Bank of Finland

Bank of Finland forecast for world economy

13


Risks to the forecast on the downside

14

Forecast assumption: weakening of confidence comes to a halt– Heightened risk aversion fades

If this not possible, the worst scenario:– New global economic recession– Broad-based banking crisis

Factors affecting the severity of downside outcome+ Corporate sector and bank balance sheets mainly satisfactory

+ Central bank liquidity windows are available- Economic policy room for maneuvre limited- Confidence in decision making under strain


Confidence in financial institutions weakened

15


Majority of European banks passed the stress test

-5 %

0 %

5 %

10 %

15 %

20 %

25 %

Lähde: EBA.

5% threshold

-5 %

0 %

5 %

10 %

15 %

20 %

25 %

Source: EBA.

16


However, banks have medium- and long-term funding falling due

0

200

400

600

800

1000

1200

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Euro area United Kingdom Other Europe

EUR bn

* Situation at 6 Sept. 2011. Chart includes 50 largest European banks.Source: Bloomberg.

17


Sovereign debt crisis is reflected in thebanking sector

18

0

50

100

150

200

250

300

350

400

450

500

1/2007 1/2008 1/2009 1/2010 1/2011

BNP Paribas Credit Agricole Societe GeneraleDeutsche Bank Commerzbank Intesa SanpaoloUnicredit BBVA Santander

Basis points

Source: Bloomberg.


Spreads between secured and unsecured interest rates in the euro area have increased again

19

0.0

0.5

1.0

1.5

2.0

2.5

1/2007 1/2008 1/2009 1/2010 1/2011

1-month spread 3-month spread 12-month spread

%

Interest rate spread as the difference between Euribor and Eurepo rates.Source: Reuters.


Excess deposits become the thermometer of the financial crisis

-50

0

50

100

150

200

250

300

350

1/2007 7/2007 1/2008 7/2008 1/2009 7/2009 1/2010 7/2010 1/2011 7/2011

Excess liquidity* in euro area banking sector (30-day moving average)

*Reserve holdings - minimum reserve requirements + overnight deposits - marginal lendingSource: Bank of Finland.

Eur bn

20


Eurosystem policy rate and money market rates

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

01/08 07/08 01/09 07/09 01/10 07/10 01/11 07/11

ECB policy rate Eonia Euribor 3 months Euribor 12 months

Source: Bloomberg

%

21


What if markets demand larger capital buffers for banks?

-5 %

0 %

5 %

10 %

15 %

20 %

25 %

Lähde: EBA.

5% threshold

-5 %

0 %

5 %

10 %

15 %

20 %

25 %

Source: EBA.

22


What if markets demand larger capital buffers for banks?

-5 %

0 %

5 %

10 %

15 %

20 %

25 %

Lähde: EBA.

8% threshold

-5 %

0 %

5 %

10 %

15 %

20 %

25 %

Source: EBA.

23


Summary: How to get out of the crisis?

24


How to get out of the crisis?

Debt crisis in a new phase– No longer a problem of individual countries– Threat of a new global recession is real

Capitalisation of financial institutions– Confidence in financial institutions weakened– Capitalisation the most effective way to restore confidence– Primarily a task of shareholders

Addressing uncertainty is pivotal– Increased loss of confidence in Europe’s ability to handle the crisis– Concrete measures essential– Implementation of July 21 decisions crucial

25


Thank you!

26

Documents

SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Bank of Finland Bulletin 4/2011 Monetary policy and the global economy Governor Erkki Liikanen 19 September