Sun Shining Onto A Tree Shoot

Quantitative easing: a race to the bottom

In the aftermath of the financial crisis back in 2008/09, the Bank of England (BoE) had considerable headroom in terms of monetary policy, and - rightly - it made full use of it. Swingeing cuts to base rates saw them plummet from 5.75 per cent to a record low of just 0.5 per cent between December 2007 and March 2009. Given the dire global economic backdrop, few could argue that such radical loosening of policy was anything but a necessity.

Likewise, most agree that the subsequent bond-buying, better known as quantitative easing (QE), was the best way to kickstart the economy, given soaring levels of fiscal debt. Back in 2009, the plan was to inject an initial £75bn into the economy to get things up and running - a rate of bond-buying which would only be considered appropriate in the case of an emergency, as it was at the time.

However, rather than wean the UK economy off QE thereafter, the Bank doubled down, and - more than a decade later - the programme has accounted for a money supply increase of nearly £450bn.

Has it actually worked?

QE has certainly played its part in providing stability to the monetary system, along with helping to fuel a miraculous jobs boom, shoring up markets and stimulating an unbroken sequence of quarterly growth since Q4 2012 - a feat not matched by any other G7 nation.

Yet since QE began, wealth inequality and asset prices have rocketed, while lower borrowing costs have played a key role in rising levels of household and commercial debt.

Most alarming of all though is that, ten years into the economic cycle, interest rates remain near record lows at 0.75 per cent. Many economists agree that the next global downturn is unlikely to commence in 2019. But, historically, a recession occurs every 10 to 15 years, which means the next one is all but inevitable sometime before the middle of the next decade. So the question becomes, with fiscal policy hamstrung by a near £2 trillion debt, what room for manoeuvre would the Monetary Policy Committee (MPC) actually have in such a scenario?

The dawn of a currency war - and more QE

Notwithstanding the various threats to global prosperity at present, the above surely articulates that the time for QE has passed, and that gradual increases to base rates is a sensible course of action. Yet, incredibly, we may well find ourselves on the brink of fresh new stimulus.

The trigger for such a prospect came a fortnight ago, when European Central Bank (ECB) president Mario Draghi effectively confirmed that a new round of QE and rate cuts would befall the eurozone in the near term. This for a currency bloc which has already seen nearly £2.4 trillion worth of bonds, asset-backed securities and government (and corporate) debt purchased as part of the programme over the last four years.

Although it is illegal to deliberately devalue currency under G7 rules, the ECB and others have simple workarounds, and this latest intervention can easily be conducted under the guise of a response to an economic slowdown - even though it is obvious that further QE for the export-dependent continent will have the natural consequence of currency devaluation, thus making Eurozone countries more competitive. 

And so it was, as the euro duly fell in the wake of Draghi's speech. Within two days, however, it triggered a response from the other side of the pond, as the Fed signalled that rate cuts are on the way in the US - reversing a process of monetary tightening over the past four years. The dollar then subsequently fell against the euro, wiping out any gains Draghi may have hoped for.

Then there are China and Japan, who have also shown themselves to be partial to devaluing the yuan and the yen respectively in recent times. Many expect them to follow suit, and who knows which other countries may do the same.

What about the UK?

The outgoing BoE Governor hasn’t necessarily pledged allegiance to further QE, but he has once again hinted that rates in the UK will not be going up anytime soon. And, with an MPC who boast a dovish track record over the past five years, markets appear to be pricing in the possibility of a rate cut.

But what a senseless course of action further rate cuts would be for the UK. Let us not forget some key differences between ourselves and our European counterparts. Inflation on these shores remains healthy, circling the 2 per cent mark. Growth, real wages and employment rates are robust. And, most compellingly, sterling remains in the doldrums in a country which imports more than it exports.

There are no winners when it comes to currency wars. The 1930s provide a clear working example of that. How ironic though that policymakers, who did a Herculean job of steadying the global economy after the crash in 2008, are the very same contingent who now threaten to destabilise it.

But simply taking no part in a currency war that Britain will not gain from is not enough. Carney, and indeed his successor (who will take office in January), need to be bolder than that. The US has offered up a successful template, slowly but surely increasing the Federal Funds Rate from 0.25 per cent in December 2015 to 2.5 per cent today - despite a less-than-perfect economic backdrop during the initial stages. Unsurprisingly, the sky hasn't fallen in, and instead the Fed finds itself in a position of strength to now drop borrowing costs if they so wish.

The MPC has largely adopted a wait-and-see approach during Carney's tenure, failing to hike base rates when conditions were benign in the middle of the decade. Yet the economy has continued to hold up remarkably well over the last few years too, despite the constant naysaying. So, with the peak of the economic cycle having likely passed, how much longer do policymakers sit on their hands for?

With a remit that requires a mix of forecasting, forward thinking and a small dose of luck, knowing when to hike rates is not an exact science - nor is it risk-free. But one thing is certain: dependence on QE is not a sustainable long-term plan, and the MPC are at risk of sleepwalking into the next downturn with their hands tied. Surely that alone merits at least dipping a toe into the waters of an alternative plan? 

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