(From Reuters)

By Balazs Koranyi

Global interest rates are likely to go even lower before they rise as financial market volatility and the specter of deflation raise fresh doubts about central banks’ ability to fulfill their mandates, policymakers and economists said.

Euro sign in front of ECB HQ in Frankfurt

With markets in turmoil and talk of further Chinese currency devaluation intensifying, expectations for U.S. rate hikes this year have all but evaporated and central banks from Europe to Canada and Australia are preparing the ground for more easing.

Faltering emerging market growth is exacerbating concerns, raising the risk that policy easing in too many places at once will cancel itself out and force national banks into a vicious cycle of competitive currency devaluation.

“The biggest risk for the world economy at this point is an aggressive policy of devaluation in China,” said the head of a major central bank in Europe, who asked not to be named.

“With uncertainty and volatility already high, it would have a big consequence for all economies.”

The People’s Bank of China has been fighting to keep the yuan stable since Jan. 6, when its second sharp depreciation in six months sparked fears of more devaluation as growth in the world’s second biggest economy, already at a 25-year low, slows.

Chinese stocks .SSEC have lost over a fifth of their value since the start of the year, while a renewed slide in oil prices, a major indicator of economic activity, took Brent crude to its lowest since 2003. The CBOE Volatility Index .VIX, the U.S. equity market’s “fear gauge” has risen sharply.

The European Central Bank responded by raising the prospect of another rate cut in March while the Bank of England has rowed back from suggestions it could start hiking rates soon.

Last week, the Bank of Japan unexpectedly lowered its key rate into negative territory, abandoning its policy of holding rates at zero to avoid potential damage to the financial system.

“The BOJ provides the strongest signal to date that the previously assumed zero lower bound on rates is no longer valid,” Deutsche Bank strategist George Saravelos said.

“Markets should now be pricing that global rates across global fixed income can sustainably and substantially trade below zero in the current and future easing cycles.”

Money markets now see the ECB’s deposit rate sinking to -0.5 percent this year from -0.3 percent ECBWATCH while the BOJ said its policies provided room for more easing if needed.

The Reserve Bank of Australia, the Bank of Canada and Sweden’s Riksbank have also highlighted risks, keeping the possibility of policy easing on the agenda. Read more

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