The eyes of the world remain fixated on the actions and promises of a few key central banks.

These banks hold the hopes of markets and nations on their shoulders. In particular, the market is banking on central banks’ taking decisive action to combat stagnant levels of growth throughout the world, as they only they can. This is something central banks have been attempting to do on-and-off since the start of the US financial crisis that crippled financial markets throughout the world, eventually mutating into the European debt crisis.

The underlying problem is a lack of demand, and without sufficient levels of demand markets/nations cannot grow at a healthy and sustainable pace. To combat this central banks have been easing growth restrictive policies and pumping stimulus into the market. To date, these policies haven’t been able to kick-start the global economy. Hence, more action is required, and has been promised or initiated in some cases, from the global economy’s last line of defence, central banks.

One of the most important modern central banks is the Federal Reserve (Fed), which operates in the US and has two key aims; to maintain price stability and max employment. The most common tool in the Fed’s arsenal is manipulating monetary policy by adjusting short-term interest rates, but it has had to reply on less conventional measures of late. This is because the Fed funds rate is already near-zero. Thus the Fed has started aiming its policy towards reducing long-term interest rates. To do this the Fed enacted operation twist and conducted two round of quantitative easing (QE) and has just announced QE3, with the former based around swapping short-dated securities for longer-dated ones and the latter involving buying government bonds and mortgage backed securities.

Another key central bank is the European Central Bank (ECB), which administers monetary policy for 17 eurozone member states. A key point about the ECB is that it only has one overriding objective, to maintain price stability.
In terms of policy, the ECB has also had to resort to less conventional techniques in an attempt to stave of an economic collapse in Europe. The difference between the ECB and the Fed is that the ECB stills has the ability to lower short-term interest rates if it wanted, but the nature of the European debt crisis means that it has to employ other measures as well.
In other words, cutting interest rates wouldn’t likely save the struggling European nations and banks that are loaded up with massive amounts of debt, albeit there has been some progress on this front. Hence, the measures used by the ECB, long-term refinancing operations and sovereign bond buying to name a couple, are aimed directly at banks and sovereigns.

In China, the world’s largest central bank, the PBoC, faces a different set of problems.

Its problems stem from an overheated economy due to the massive amounts of stimulus pumped into it in response to the financial crisis. Nonetheless, the lack of global growth has played a large part in the slowing of the Chinese economy, along with Beijing’s own attempts to rain in growth by tightening policy. Combined, these problems create a significant challenge for the Chinese government; how to simulate the economy without reigniting the problems that emerged as a result of the stimulus of 08/09.
Beijing’s answer thus far has been a measured attack on weak levels of domestic demand. The PBoC has cut interest rates and the reserve requirement ratio (RRR), which dictates how much capital large Chinese banks must hold in reserve, and there has also been an increase in government spending, although it is far of the steroid injection on 08/09.

Yet, despite all of the aforementioned attempts to kick-start the global economy, many problems and challenges lie ahead for central banks throughout the world. The market, in particular, is going to be paying very close attention the latest round of promises/stimulus from the ECB/Fed.

The question everyone is asking about the US economy is; will QE3 be able successful in meaningfully reducing unemployment? Looking back at QE1 and 2 one could draw the conclusion that they didn’t do what they were designed to do. However, on the other side of the question many analysts believe that the US job market would be in a worse position now than without the implementation of the first two rounds of QE. The answer lies somewhere in the middle – they were somewhat effective but not as effective as the Fed hoped they would be. There is a chance QE3 will be more successful than its predecessors as it is aimed more towards buying mortgage backed securities which are at the crux of the problem in the US, the housing market. In any event, we think the US economy will recover; it may just take a little longer than the market expects.

In Europe, we expect to see relatively weak growth figures for the foreseeable future. Nonetheless, the ECB has been instrumental in staving off an economic collapse in Europe, and will continue to play a key role in bringing Europe back from the brink, especially through the use of its outright monetary transactions program (OMT). Under this program the ECB has said it will buy unlimited amount of government bonds once the nation(s) in question apply for a bailout from the regions rescue funds. This basically means the ECB has agreed to become lender of last resort, which is great news for struggling sovereigns and the market.

The PBoC hasn’t taken as much drastic action recently as the Fed and the ECB, largely because its problems aren’t as severe. However, the PBoC has been very active in China’s financial markets in an attempt to increase liquidity. To do this the central bank conducts open market operations (OMO), usually by selling reverse repos to major banks. However, the bank is somewhat limited in what it can do. The PBoC has to keep a close eye on inflation and house prices to ensure they don’t get too high, which would potentially be very detrimental to the Chinese economy. However, we think the PBoC has both the will and the tools to prevent a hard landing in China.

Overall, central banks throughout the world are attempting to stimulate healthy economic growth. Whilst some of the operations conducted by the ECB, Fed and PBoC have failed thus far to spur global growth, they have gone a long way to calming investor sentiment and preventing a collapse of the global economy.