European Central Bank President, Jean-Claude Trichet, is forecasting global positive growth in 2010, but believes the recovery will be sluggish.
The sluggish growth view will cause central bankers to take a “wait and see” type of approach to monetary policy. If they act too soon or too aggressively, higher rates will deflate the recovery. Much of the turn around and recovery so far has been a result of loose monetary policy. Therefore, it has been artificial and if it is pulled away, the recovery is likely to leave with it. Therefore, expect rates to remain low for a significant period of time, unless prices begin to steadily rise.
Central banks are facing the risk of stagflation and that risk is increasing over time. With the record setting inflation (i.e. the growth in money supply) produced by central banks recently, they will need to tighten in order to avoid significant price increases and devaluation of their respective currencies.
Trichet also called for banks to improve their risk management, but it’s a mixed message. While central banks and governments are calling on banks to improve and tighten their risk management, they are also calling on them to lend more in order to get credit flowing in an effort to spark growth. Loose monetary policy and the artificially low interest rates they produce also act to increase risks taken on by banks.
