“One uncomfortable truth is that there are limits to what the Bank of England can do. In particular, monetary policy cannot immediately or fully offset the economic implications of a large, negative shock” - Mark Carney, 30 June 2016.
As Brexit aftershocks continue to unsettle investors around the world, the ability of central banks to influence the direction of financial markets is under scrutiny. In this article, Will Walker-Arnott from Charles Stanley discusses whether we have reached the end of the road in terms of impact of central bank policy and, if so, on whom does it fall to stabilise financial markets? This article, while it uses a UK example, is relevant globally and we hope readers will find it useful. The editors of this publication invite responses; as always, the views of the authors are not necessarily endorsed by the editors of this news service but we greatly value such contributions.
When the Governor of the Bank of England, Mark Carney, stood up to reassure investors on 30 June, he promised to restart monetary stimulus during the summer months to try and save the UK economy from a Brexit-induced malaise. For me, the promise to allow investors to continue to drink from the punch bowl of monetary stimulus was not the significant takeaway from his speech; rather, his concession that there are limits to the powers of the central banks stood out. This is surely a significant moment. Since the financial crisis investors have become reliant on central bankers to ride to the rescue and keep the financial markets orderly and upbeat. Have we now reached a new phase in the economic cycle where the ability for central bankers to influence market conditions and investor behaviour is beginning to dwindle?
There have certainly been clear signs that the power of the central banker is beginning to wane in recent months. Let us firstly examine the position of the world’s most powerful central bank: the Federal Reserve in the US. In December 2015, in a historic move, Janet Yellen announced that the Fed was going to raise interest rates for the first time since 2006. In hindsight this rate hike now looks like a mistake – in May 2016 we had very disappointing employment data from the US with only 38,000 new jobs created. This was well below the 160,000 figure predicted by economists and the futures markets are now suggesting that we will not have another rate rise until 2017. With question marks hanging over Yellen’s ability to predict future economic growth and adjust policy accordingly, the markets are likely to pay less attention to her prognoses going forward.
Japan is the home of unconventional monetary policy. It is after all the country where the concept of quantitative easing first emanated. Japan is still battling to emerge from several decades of deflation and sluggish economic growth. In January 2016, Bank of Japan governor Haruhiko Kuroda announced an innovative policy to introduce negative interest rates in an attempt to finally jumpstart the economy. So far, this radical policy has not had the desired effect and resulted in a rapidly appreciating yen, which has exerted significant pressure on the country’s major exporters and hurt their profitability. Surely, the BoJ’s apparent miscalculation will only serve to undermine the credibility of central banks around the world and further diminish their ability to support financial asset prices going forward.
Mario Draghi, president of the European Central Bank, recently spoke at the ECB’s annual forum in Sintra, Portugal. During his keynote speech Draghi said that the pursuit of aggressive monetary policy from the world’s central banks has created “destabilising spillovers” around the globe. The ECB chief highlighted big swings in exchange rates and reversals in capital flows to emerging markets as some of the consequences of extraordinary central bank action in the wake of the financial crisis. Once again, this seems an admission that the power of central bankers is limited and that often their policies do not have the desired effect.
There is no doubt that global central banks played a significant role in the immediate aftermath of the financial crisis in stabilising the global economy. However, it is now apparent that their ability to influence markets is beginning to wane and this should concern investors. The clamour for helicopter payments continues relentlessly. But I suspect that further monetary policy experimentation is not the answer. The baton should now be passed to our politicians to introduce much-needed fiscal stimulus. This week we saw the 10-year gilt yield in the UK drop below 1 per cent for the first time in history. Politicians around the globe now need to do their part and should take advantage of these cheap borrowing rates and invest in projects to improve ailing infrastructure around the globe. They must not let recent macro-political events distract them from the dawn of a new economic era where central bankers have considerably less influence on global markets. It is time for politicians to step up to the plate before Japan’s recent economic malaise becomes a global phenomenon.