European Central Bank (ECB) President Christine Lagarde (Reuters)
European Central Bank (ECB) President Christine Lagarde (Reuters)
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Central banks struggle to confront threats to markets, economies from virus

Unlike the financial crisis over a decade ago, there’s limited scope for cutting interest rates to stimulate growth

The world’s major central banks are straining to tamp down threats to financial markets and the global economy created by the coronavirus pandemic, held back by limited tools and a new kind of risk from outside the financial system they are set up to manage.

Stocks rallied Friday, in part on signs of progress in Congress toward passing measures to support the economy. However, beneath the surface, Wall Street was under growing pressure as financial firms rushed out of complex bond market trades that pushed up long-term U.S. Treasury borrowing rates, which typically go down in a crisis.

In response, the Federal Reserve accelerated a program announced just a day earlier to pump funds into the financial system and stabilize the rise in long-term interest rates and other credit costs. The Fed is expected to cut short-term interest rates next week and could take other steps as part of its ramped up efforts to lift the economy.

The Bank of Canada cut its main policy rate by a half-percentage point Friday, while the European Central Bank sought to reassure investors and governments about its support a day after ECB President Christine Lagarde sent unnerving signals of a limited response from Frankfurt. China’s central bank pumped roughly $80 billion into commercial banks as part of continuing efforts to ensure the stability of its financial system. Australia’s central bank also added funds to its banking system.

“There is every reason to be concerned that what we’re seeing on the ground with this virus and in this market, the response [of global central banks] might not be big enough," said Bruce Kasman, head of economic research at J.P. Morgan.

The world’s central banks are trying to manage several shocks simultaneously. The most pressing problem Friday was reducing market disruptions tied to economic uncertainty.

Market mayhem turned from falling stock prices to bond volatility not seen since the financial crisis over a decade ago. U.S. banks, some analysts said, are constrained by postcrisis capital and liquidity regulations that limit their ability to cushion blows to the market. Hedge funds, others said, were tied up in bond trades that become highly unprofitable when volatility rises. Unwinding those trades only increases volatility.

The Fed and other central banks are responding by making sure banks are flush with funds to back loans, credit lines and trading so the economy’s problems aren’t compounded by a malfunctioning financial system. The central bank said Friday it would pump $37 billion into the system by purchasing Treasury securities from banks—nearly half of what it said Thursday it would do over months.

“These purchases are intended to address highly unusual disruptions in the market for Treasury securities associated with the coronavirus outbreak," the New York Fed said.

The next problem will be finding ways to stimulate economic growth as consumer and business activity slows in many nations.

While central banks have ample resources to pump money into the financial system, they are constrained in how much they can stimulate the broader economy because interest rates are already very low. Low interest rates boost economic growth by encouraging households and businesses to borrow, spend and invest, pulling forward outlays that might otherwise be put off until later.

In Japan and Europe, however, central bank target rates are already below zero. The Fed’s benchmark rate is between 1% and 1.25%. During the 2007-09 crisis, it cut the rate by more than 5 percentage points. It doesn’t have the room to do that now.

After the last crisis, central banks also resorted to a policy known as quantitative easing, in which they purchased bonds to push down long-term interest rates. But these rates are exceptionally low, too. In the U.S., for instance, the yield on a 10-year Treasury note is below 1%. In Germany and Japan, the comparable yields are negative.

Central banks aren’t unified in how they’ll proceed.

The Bank of Japan, for instance, is hesitant to join the Fed and other central banks in cutting interest rates because its target is already below zero, and it wants to focus on supporting companies affected by the epidemic, according to people familiar with the bank’s thinking.

“There is no urgent demand to take concerted action all at once," said one person familiar with the BOJ’s thinking. “Each central bank is under different economic conditions and has a different policy with different effects, while the room left for further easing is also different for each bank."

A new cast of characters is also in charge, some without much experience leading central banks in a crisis. Fed Chairman Jerome Powell, often criticized by President Trump, has been in the top job for two years. Bank of England Governor Mark Carney, who cut U.K. rates earlier this week, steps down from the job Sunday, to be succeeded by Andrew Bailey. Ms. Lagarde was France’s finance minister during the financial crisis but is new to central banking.

Investors were unnerved by her remarks earlier this week. At a news conference Thursday, she urged governments to take some of the burden off central banks in controlling the spreading economic crisis. She also suggested she wasn’t prepared to address a widening gap in government borrowing costs between different eurozone members, a gap economists typically call a spread.

The remarks aggravated a market rout that caused a sharp jump in Italy’s sovereign borrowing costs and a 17% drop in the nation’s main stock market index. In a blog post Friday morning on the ECB’s website, the bank’s chief economist, Philip Lane, signaled the central bank is ready to buy Italian government bonds to help.

“We clearly stand ready to do more and adjust all our instruments, if needed to ensure that the elevated spreads that we see in response to the acceleration of the spreading of the coronavirus do not undermine transmission," Mr. Lane wrote.

—Megumi Fujikawa in Tokyo contributed to this article.

This story has been published from a wire agency feed without modifications to the text.

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