The end of ‘QE infinity’? Gavyn Davies

https://www.ft.com/content/f36a1403-cfbc-3db9-a89c-14beef198e5f

Until recently, the rate of expansion in global central bank balance sheets seemed likely to remain extremely high into the indefinite future. Although the US Federal Reserve had frozen its balance sheet, both the European Central Bank and the Bank of Japan were pursuing open-ended programmes of asset purchases, and the Bank of England actually increased its intended stock of assets by £50bn in August. Global central bank balance sheets were rising by about 2 percentage points of GDP per annum – a similar rate to that seen since 2012.

Some commentators argued that the central banks would never step aside from their programmes of balance-sheet expansion. After QE1, 2 and 3, we would get “QE infinity”. Others argued that unlimited quantitative easing would result in disaster, either through rapidly rising inflation, or bubbles in asset markets.

Neither of these dark outcomes has occurred. Instead, it seems that policy makers are moving away from QE because it is no longer effective and no longer necessary. “QE infinity” is coming to an end, not with a bang but with a whimper.Surprisingly, one of the most enthusiastic proponents of QE, the UK, now seems to be in the vanguard of the change. Another proponent, the BoJ, has already declared an armistice. The Fed is moving in the opposite direction from QE infinity. Only the ECB still seems to be “with the programme”, and even that is increasingly dubious.

Events in the UK this week have been particularly fascinating. Before the Conservative party conference, it seemed likely that fiscal policy would be eased in the Autumn Statement on 23 November – or, at least, the “austerity” of the former chancellor George Osborne would be abandoned – and that the BoE would maintain its programme of aggressive monetary easing. The markets were prepared for higher budget deficits, financed by more rounds of QE.

What has changed? First, the economy has delivered a major upside shock to policy makers in the past few weeks. Whereas it had been assumed that spending decisions would be delayed owing to uncertainty after the Brexit vote, it now seems that this happened before the vote, and that there has been a catch-up in spending as confidence has recovered since August.

Meanwhile, the weakness in sterling has clearly increased inflation expectations, which are now approaching 3 per cent. Aggressive monetary accommodation is looking much less appropriate, especially after the “air pocket” for sterling this morning.

In addition, there has been a pronounced shift in the government’s political rhetoric on the correct policy mix in the UK. Prime Minister Theresa May has been ruthless in throwing out many of the people associated with the Cameron regime, and now she seems ready to abandon the main plank of Mr Osborne’s economic strategy. She has said explicitly that QE has had adverse side-effects, and her advisers have talked about a much more expansionary fiscal policy instead of more monetary easing.

The new chancellor, Philip Hammond, sounds less convinced that fiscal policy should be eased markedly, talking instead about a postponement of the date of budget balance from 2020 until a bit later on. But it is clear that the budget balance will follow a very different path from that shown in the final Osborne plan, and there could be special dispensation from “budget balance” for extra capital spending on infrastructure and housing.

What does that mean for Mark Carney at the BoE? He is in a tricky position, because he expected the economy to weaken markedly, and understandably embarked on a major new monetary easing in August. But the recovery in the economy, the fall in sterling and the prospect of further fiscal easing make a combination that might force him to change his mind.

Furthermore, there is a faint possibility that the new regime in Downing Street will rewrite the agreement between the government and the BoE on government bond purchases by the central bank. The Treasury needs to give permission to the Bank to conduct these purchases. Any restriction on it’s free hand on bond purchases would have a large gilts market impact, and could lead to a rebound in sterling.

QE has clearly boosted asset prices, and stands accused of increasing inequality and reducing returns on savings. Mrs May is sympathetic to these criticisms. If she really wishes to end QE for political reasons, she can easily enforce an exchange of letters with Mr Carney that increases the economic hurdles that QE needs to clear.

Elsewhere in the world, QE also looks under threat. The BoJ has effectively abandoned its balance sheet target in favour of a target of zero for long-term JGB yields. A price target has replaced a quantity target, with uncertain effects on the central bank balance sheet. The Fed is focused mainly on the speed at which interest rates will rise towards equilibrium, though chairman Janet Yellen is still holding more QE in reserve if the economy weakens unexpectedly. A President Trump, and many Republicans in Congress, would be very opposed to that.

That leaves the ECB, which is in a very difficult position. Some members of the Governing Council are obviously beginning to think that there is a practical limit on the quantity of bond purchases that can be undertaken without changing the national distribution of bond purchases (the “capital key”) or the limit on purchases of bonds with negative yields. Others are impressed by the signs of improvement in the economy, and want to stop QE anyway.

But it is very hard for the ECB to follow the BoJ by placing a cap on yields because of differences in yield levels between member states, so no obvious alternative is available. A fudge, with some tapering of bond purchases, seems likely next year.

Overall, the era of unlimited global QE seems to be ending. The policy experiment was probably successful in the years when bond yields could be driven lower, thus easing monetary conditions, but lately the experiment has become rather pointless in the countries that faced a deflation threat. Zero yielding bonds have been swapped for zero yielding cash, which is not exactly a profoundly important switch.

The market consequences of all this are worth pondering. Long-term bonds will not be favoured, and equities will receive less “artificial” help from central banks. It is true that global monetary policy is not about to tighten. But we are about to pass an important line in the sand.

——————————————————————————-
This message may contain confidential or privileged information. If you are not the intended recipient, please advise us immediately and delete this message.
The unauthorised use, disclosure, distribution and/or copying of this e-mail or any information it contains is prohibited.
This information is not, and should not be construed as, a recommendation, solicitation or offer to buy or sell any securities or related financial products. This information does not constitute investment advice, does not constitute a personal recommendation and has been prepared without regard to the individual financial circumstances, needs or objectives of persons who receive it.

---

Archr LLP is Authorised and regulated by the Financial Conduct Authority (FCA reference 617163).
Archr LLP is not covered by the Financial Services Compensation Scheme (FSCS).
Archr is registered in England and Wales No. OC371018. Registered office 115B Drysdale Street, Hoxton, London, United Kingdom, N1 6ND

This message may contain confidential or privileged information. If you are not the intended recipient, please advise us immediately and delete this message. The unauthorised use, disclosure, distribution and/or copying of this email or any information it contains is prohibited.

This information is not, and should not be construed as, a recommendation, solicitation or offer to buy and sell any securities or related financial products. This information does not constitute investment advice, does not constitute a personal recommendation and has been prepared without regard to the individual financial circumstances, needs or objectives of persons who receive it.

You are receiving this email because you are a valued client of Archr.