Here, just for you dear readers, is a selection of analyst reaction to the Bank of England’s surprise Thursday decision to extend quantitative easing by £50bn.
The highlights are our own, throughout, and we are starting off with the basics of the decision, courtesy of JP Morgan economist Malcolm Barr:
The MPC decided to extend asset purchases by £50bn to £175bn, with the Chancellor raising the remit to £175bn to allow that to occur. The decision to move this much is a surprise to us, and underlines the MPCs determination to see broader evidence of a return to significant output growth as a means to deliver on its inflation objective. The purchases will take three months, taking us through to the November Inflation Report meeting.
We await the detail of the Inflation Report, but note in the meantime that such action is not without it’s risks: our read on the data is more upbeat than the MPC’s, and we are concerned at the potential for headline inflation to spike higher in early 2010 as VAT rises. Meanwhile this action takes the scale of QE up to 12% of GDP, and exactly how that action will translate into the behaviour of the money and credit aggregates remains difficult to call. The potential for the exit from this policy to be messy, if it is successful in boosting growth, is increasingly clear. Even before today, however, we had recognised the data had a long way to travel to deliver on our call for a modest tightening early next year, and given today’s surprise are pushing that call back to 2Q10.
The statement announcing the decision is quite lengthy . . . but we note the following:
· The MPC continue to downplay what the PMI surveys are telling us about growth both in the UK and globally. They state “The world economy remains in recession” before qualifying that with signs of stabilisation in the UK’s main export markets. More specifically for the UK “some recovery in output is in prospect, but the margin of spare capacity in the economy is likely to grow for some time yet”. So the MPC does not see UK growth approaching potential for a while. Admittedly, the improvement in the PMI survey is yet to broaden to other business survey measures, but the MPC are clearly loathe to extrapolate what the most timely of the measures are telling us at this stage.
· Aside from the current issue of momentum in the recovery phase, the statement that “the recession appears to have been deeper than previously thought” serves to underline the role that the level of output in the official estimates is playing in their assessment of the degree of inflation pressure.
· Two references to the complex of money and credit data suggest the MPC is somewhat disappointed by the traction they have gained with low rates and QE thus far: underling broad money growth “remains weak” while “lending to business has fallen and spreads on bank loans remain elevated”. That bank balance sheet restructuring and high debt levels will restraining the recovery remains the MPC’s key concern.
And a bit more detail from Monument Securities’ Marc Ostwald:
Increasingly the MPC has to be said to have a propensity for surprising markets, and while we may speculate about the degree of unanimity about this decision given some less than ringing endorsements for a hike in the volume of QE in recent speeches, or at least so it appeared, any revelations will have to wait for the minutes, with the immediate focus being on next week’s inflation report.
The statement acknowledged that there has been some troughing in economic growth terms both here and abroad, and that “financial market strains have eased and banks’ funding conditions have improved a little”, and that “there is a considerable stimulus still working through from the easing in monetary and fiscal policy and the past depreciation of sterling”. It emphasized on the other hand that “the recession appears to have been deeper than previously thought”, “financial conditions remain fragile”, “the margin of spare capacity in the economy increased further and pay growth remained weak” and “the need for banks to continue repairing their balance sheets is likely to restrict the availability of credit, and past falls in asset prices and high levels of debt may weigh on spending. While some recovery in output growth is in prospect, the margin of spare capacity in the economy is likely to continue to grow for some while yet, bearing down on inflation in the medium term. But the recession and the restricted availability of credit are also likely to impact adversely on the supply capacity of the economy, moderating the increase in economic slack.”
All in all it appears that they are looking at the Japanese experience, and were keen to ensure they do more rather than less. Presumably, the inflation report will show that without the additional £50 Billion inflation will undershoot the 2.0% target on a 2-year time horizon, and that their growth forecasts will be revised down somewhat.
As for the widening of the maturity bands, and the opening of a DMO repo book on the BoE’s APF/QE holdings, this was inevitable given the obvious illiquidity in the ‘free float for a number of Gilt issues and the prior exclusion of 3 stocks from the original programme. Given the stated intention that this will be carried out over three months, it implies a £3.75 Billion per week pace for QE buybacks, which is slightly below the imputed an average pace of DMO issuance of around £4.2 Bln, and obviously well below the £65 Bln pace of buybacks for May and June and much of July. So the market will need to find some “new cash” from somewhere relative to the initial period of QE, even though this may not be of immediate concern to many. Tacitly, there should also be some easing of the upward pressure on mortgage rates, given the inclusion of the 3-5 yr sector of Gilts. Equally the introduction of a 25 yr plus basket introduces an element of risk to ultra-long Gilts as when the QE process comes to an end , which in theory at least had hitherto been absent.
And the analysts at Standard Chartered widen the net to examine the impact of central bank QE-type liquidity ops from around the world:
The rally in higher-beta assets such as credit, equities, commodities and currencies has been liquidity driven, courtesy of the world‟s central banks. A key characteristic of such a rally is that it is broad based, resulting in a sharp increase in cross-market correlations. From 1 January to 1 August, the correlations between the S&P 500 index and the Shanghai composite, the EMBI Global, crude oil and gold have been 6.3%, 48.7%, 45.8% and -3.3% respectively. However, from 1 July to 1 August, the same correlations were 12.8%, 52.4%, 56.2% and 49.2%. Similarly, in the last month, the correlations between crude oil and the EMBI global, gold, the Shanghai composite and the AUD-CHF cross were 88.4%, 68.9%, 52.1% and 47.8% respectively.
Massive liquidity injections via interest rates and quantitative easing have been the drivers for this rally. At the macroeconomic level, the evidence for this has come in the form of soaring global money supply growth. For example, from a recent low of 5.4% y/y in August 2008, US M2 growth almost doubled to 10.0% y/y as of January this year. China‟s monetary expansion has been extraordinary. From a low of 14.80% y/y in November 2008, M2 growth has accelerated to 28.46% y/y as of June. Even Japan – not renowned in recent years for its economic vigor – has seen a bounce in M2 growth from 1.8% y/y to 2.7% y/y.
Liquidity-driven rallies, at least initially, are typically indiscriminate, lifting the fundamentally sound along with the more fragile. This is until considerations of valuation get in the way. We may be reaching such a point. Moreover, the liquidity boost itself may be ebbing. While US M2 growth is still accelerating y/y, its rate of m/m acceleration is moderating. Eurozone M2 growth decelerated y/y to 4.8% in June from 5.0% in May. Finally, there is talk of “exit strategies” from the extraordinary easing of the last 12 months.
On the face of it, much of this is decidedly negative for the liquidity-driven bulls. Indeed, just the hint of liquidity tightening by China has been enough to cause sharp sell-offs across global markets – encouraging the Peoples Bank of China (PBoC) to stress that it will maintain “moderately loose” monetary policy. Price action in higher-beta assets over the last two weeks has looked tired, suggesting we may see a further bout of profit taking. Moreover, the deceleration in money supply growth in some countries is adding to investor concern. However, the fact that the Bank of England (BoE) chose to expand its quantitative easing (QE) programme shows that policy makers are well aware of the link between inflating asset prices and nominal GDP. Talk of “exit strategies” remains premature. Policymakers will continue to focus on maintaining adequately loose policy to support economic prospects into 2010, even if the cost of that is some inflation. Profit taking notwithstanding, that prospect should support higher-beta assets for some time to come.
Got that, readers? The QE-inspired rally shall continue, apparently, while Britain seeks to avoid becoming Japanese and studiously avoids coming up with an exit strategy. Beta is the new alpha, and all that.
Related links:
Bank boosts quantitative easing programme to £175bn – FT
Gillian Tett: The liquidity pipes remain clogged – FT
Allocating, multiplying QE - FT Alphaville