James Klempster (pictured), head of portfolio management at Momentum Global Investment Management asks, has quantitative easing become a victim of its own success?
While it had been used before, Quantitative Easing (QE) really only came into our collective consciousness when the US Federal Reserve used it following the global financial crisis. The purpose of QE is to firstly support or push the prices of assets higher, which in turn results in an enhanced feeling of wealth for the holders of those assets and secondly, because many of the purchased assets were fixed income securities, QE served to pull down interest rates. This rendered low risk fixed income assets unattractive in terms of their total returns, which pushed investors into riskier assets in search for better yields. QE is now a cornerstone of central bank extraordinary monetary policy, and has been used to great effect. Yet recent activity by the Bank of Japan (BoJ) and European Central Bank (ECB) has placed increasing reliance on negative interest rates rather than relying solely on tried and tested QE.
This has led to suggestions that QE is, perhaps, losing some of its punch; are we now in the era of Quantitative Exhaustion? An important tenet of monetary policy is that, for it to be impactful, it should have an element of surprise. QE has become such ubiquitous monetary policy tool that there is undoubtedly a risk that its use has become too mainstream in nature, leading to diminishing returns in terms of its use. A reduced impact is not the same as being obsolete, however, and it is telling that central banks, while relying less on QE to provide new stimulus, are extremely reluctant to begin to unwind the huge volumes of securities amassed under QE. Arguably this is because to do so would be a huge surprise today, and would result in a large and – probably – negative impact on confidence, which could readily filter through to real economic activity.
Developed market inflation remains stubbornly low, which calls into question the efficacy of a swath of extraordinary monetary policy tools used in recent years. This misses the substantial impact on inflation from dropping commodity prices globally, but the likelihood now seems to be that the major mathematical impact of falling input prices is behind us and should stabilise or lead to inflationary pressures in coming months. Furthermore, central banks such as the ECB and BoJ continue to act so as to put pressure on their currency through negative interest rates. A weakened local currency will aid a country’s competitiveness in the context of global peers leading to export led activity whilst, at the same time, pushing import prices up in local currency terms, which should be inflationary.
From a longer term perspective, there are a large number of unknowns in terms of QE’s impact and these may, in time, tarnish QE’s reputation: more QE is probably storing up longer term problems such as inflated asset prices and bubbles, as well as reducing pressure on governments to take much needed structural reform measures. Negative interest rates are not without issues either, with concerns over bank profitability in this environment being one of the reasons that bank share prices were so weak earlier this year. It seems that ECB’s introduction of measures to address this, in particular the new Targeted Long Term Refinancing Operation and the cut to zero of its refinancing rate, demonstrated the ECB’s acute awareness of this problem and a clear message that robust bank profitability is important for the credit transmission policy
