QE vs QT
Although the Bank of Japan first used Quantitative Easing (QE) a decade and a half ago to combat falling prices, the “unconventional” policy is principally a child of the Global Financial Crisis that began in 2007-08. The central banks of Japan, the United States, Britain and, eventually, Euroland created money which they used to purchase government bonds on a grand scale. They had already taken the price of money – interest rates – as close to zero as they practicably could. The only way to widen its availability any further was to print more of it – the “quantitative” part of QE.
Ten years on, the monetary policies of the big central banks are beginning to diverge. In Tokyo and Frankfurt the printing is still going on while in Washington QE has given way to what might be called Quantitative Tightening. The Federal Reserve is taking rates higher and it has begun to reduce the $3.5 trillion stock of government and other bonds that it built up during the QE years. It will not actually be selling them off: financial markets might find that prospect too scary. Rather, it will gradually stop reinvesting the proceeds of maturing bonds, eroding that $3.5 trillion mountain. Either way, there will be fewer dollars in circulation.
More expensive money
The Bank of England is nowhere near following the Fed on that tack but it is now talking seriously about higher interest rates. Having halved its Bank Rate to 0.25% in the wake of the Brexit referendum it is now preparing investors for a move back up to 0.5%. Economists, who rarely agree on anything, are divided on the merits of doing so. Some say it is a necessary step towards getting monetary policy back to “normal”. Others say it is too soon, even though inflation is well above its 2% target.
Still, the BoE has sent clear signals that the increase will happen “in coming months”, which investors take to mean on 2 November or 14 December, the next two scheduled dates for rate announcements. That prospect has been positive for sterling recently. Although the last week was not particularly kind to the pound – it lost half a euro cent and two and a half US cents – it has been the top performer over the last month, strengthening by an average of 4.6%.
Andy Haldane, the Bank of England’s chief economist, seemed to favour the move when he told a TV interviewer that the Monetary Policy Committee is “nearing the point” where it will increase interest rates. He argued that “rather than being a source of fear or trepidation, this ought to be a good news story” because it means the economy is doing all right. Although Mr Haldane did not say so, it ought also to be a good news story for the pound: investors tend to be attracted to currencies with rising interest rates.
There is no suggestion that a rate increase this year must be followed by others in 2018. It is quite possible that the BoE could make its move and say, at the same time, that investors should not hold their breath for the next one. If investors were to see the increase as a one-off they could lose some of their interest in the pound, limiting its upward potential.
Sarah, Senior Account Manager at Moneycorp
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