Markets are still hanging on every word that is said by the major central banks. May’s rate cut by the European Central Bank was widely anticipated and welcomed. Unclear rhetoric from the US Federal Reserve and the Bank of Japan has contributed to an uptick in market volatility, however.
Fed chairman Ben Bernanke’s statement before the US Congress was full of assurances that quantitative easing was providing significant benefits and that premature tightening of monetary policy would risk slowing the recovery. When pressed in the questions that followed he stated quite reasonably that in the event of sustained improvement in economic indicators the rate of asset purchases could begin to be scaled back within the next few months.
In Japan, BoJ Policy Board minutes were released showing that some members of the board had doubts about the possible effects of the unprecedented expansion of the bank’s balance sheet on Japanese government bonds and on the BoJ’s credibility should its inflation target not be met.
In both cases doubt has been cast on the future path and effectiveness of monetary policy, which has caused volatility in bond and equity markets.
Our view remains that base rates are likely to stay low for the foreseeable future. Economic recovery has so far been slower and more fragile than following previous recessions and fiscal tightening will continue to be a drag on growth throughout the developed world. Higher rates would risk choking off investment and slowing consumption just when they need to be carefully nurtured. Current QE programmes will ultimately tail off, and it is likely that this will happen first in the US where the recovery is most solid, but there is potential that further support may be required in future.
Having said that rates will remain low, there is little prospect of them falling significantly lower. Mario Draghi has stated that the ECB is technically ready to use negative interest rates, and Germany has issued short term bonds at negative yields, but the widespread adoption of negative rates seems unlikely while QE has shown itself to be effective in promoting confidence.
Matt Hoggarth is an investment analyst at Thesis Asset Management