London: When central banks first embraced quantitative easing in 2009 to lift the world economy from the ashes of the Great Recession, it was only half-jokingly dubbed “QEternal” given that it could be a process that would last years.
After the Brexit shock, few are laughing now, and another wave of quantitative easing (QE) that will see tens of billions of pounds, euros, yen — and perhaps even dollars — pumped into the system is imminent.
Bond yields around the world have plunged since the landmark vote, some to multi-year lows and some to their lowest on record. More than $11 trillion (Dh40 trillion) worth bonds now yield less than zero, according to Fitch Ratings.
And they look set to fall further, turning the screw even tighter on banks, pension funds and a wide range of investors who are seeing their returns evaporate almost by the day.
The Bank of England (BoE) is expected to reactivate its bond-buying QE programme, which stands at £375 billion (Dh1.8 trillion) and has been dormant for four years, and the European Central Bank (ECB) and Bank of Japan (BoJ) to extend and expand their current programmes.
BoE governor Mark Carney said on Thursday that further stimulus in the coming weeks to help cushion the UK economy from the Brexit shock is “likely”. Even the Federal Reserve might be forced to consider “QE4” if the economy fares sufficiently worse than policymakers expect.
“QE? It’s possible. The Fed could lower interest rates first, go to zero or slightly negative, maybe -0.25 per cent,” said Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics in Washington and former Fed official who played a prominent role in the central bank’s first QE programme in 2009.
“At that point, if they needed more, they could go to QE.
That’s a long shot. However, Brexit does put us a little bit closer to a place where it might be considered,” he said.
The Fed’s third round of QE nominally ended in October 2014.
The central bank has expanded its balance sheet by approximately $3.6 trillion with its purchases of bonds, mostly Treasuries.
But the Fed is constantly buying Treasuries to maintain its balance sheet at that size. Its rollover and reinvestment of maturing bonds have picked up by around $216 billion in 2016, with another $900 billion due in the three years after that.
If nothing else, investors no longer expect the Fed to follow up last December’s rate hike any time soon, if at all.
The 10-year Treasury yield, the world’s benchmark borrowing cost, slumped to within a whisker of its all-time low of 1.38 per cent on Friday.
Quantitative failure?
The fall in bond yields elsewhere is no less dramatic.
Benchmark 10-year borrowing costs in Britain, Japan, Switzerland and a host of countries in the Eurozone are their lowest in history. Many of them are below zero.
They were low and falling before Brexit, depressed by worries over the durability of the post-2009 global economic recovery, persistently low inflation and inflation expectations, and central banks’ ability to address those concerns.
But Britain’s vote to leave the EU has reinforced that trend as economists have cut their growth forecasts, most notably for the UK, but also Europe and beyond.
Economists at Credit Suisse now expect the UK economy to shrink by 1 per cent next year, compared with their previous forecast of 2.3 per cent growth. They also expect the BoE to boost QE by £75 billion to £450 billion.
David Blanchflower, professor of economics at Dartmouth College in New Hampshire and a former BoE policymaker, agrees that a UK recession is coming. Rate cuts are a near certainty, potentially followed by more QE.
“In 2008 we had a deep economic crisis. Now we have an economic crisis exacerbated by a deep political crisis,” he said.
The ECB is also expected to expand or extend its €1.74 trillion (Dh7.1 trillion) QE programme scheduled to end next March as it battles to lift inflation back to target of just under 2 per cent from around zero.
Eurozone inflation expectations as measured by the five-year, five-year break-even forward — the ECB’s favoured measure of market inflation expectations — fell to a record low 1.2671 per cent this week.
The ECB is in a bind though. Trillions of euros of bonds including around half of all outstanding German debt are no longer eligible for purchase because they yield less than the ECB’s threshold of -0.40 per cent.
And not everyone is convinced more QE will do any good.
Growth is slowing and inflation expectations are falling around the world despite the trillions of dollars worth of stimulus sloshing around the system.
Analysts at Bank of America Merrill Lynch have dubbed QE “Quantitative Failure”, and Andrew Sentence, Senior Economic Adviser at PwC and ex-BoE policymaker, reckons the bank should wait until incoming data gives a clearer picture of the Brexit impact.
“Extra QE or a small further cut in rates are likely to have a marginal impact on the economy. If I was on the MPC [Monetary Policy Committee] I would be arguing for stability — hold rates and no extra QE,” he said.
