July 5, 2013 2:01 pm
The ECB and BoE felt compelled to respond to events two weeks earlier. Then, the Federal Reserve’s Ben Bernanke announced a timetable for removing, or “tapering”, the stimulus he is injecting into the US economy. The market was amazed that he suggested that the stimulus could be ended altogether as soon as the middle of next year.
To counter rising rates, the ECB said it “expects the key rates to remain at present or lower levels for an extended period of time”, while the BoE’s new governor, Mark Carney, said “the implied rise” in future rates was “not warranted by the recent developments in the domestic economy”. In other words, the market had set gilt yields too high.
As a result, although the Fed is still buying bonds, while the ECB’s balance sheet is contracting, the extra yield on German Bunds compared to US Treasury bonds reached its highest since the crisis.
There is irony here. When the Fed launched its programme of bond purchases in early 2009 – arguably a form of printing money – the rest of the world complained that it was fighting “currency wars”.
Low US rates made for a weak dollar, and cheaper US exports. The response was for other countries to cut their rates. In effect, the Fed exported its low interest rates. Now the problem has reversed. The Fed is exporting higher rates, and the ECB and BoE have been forced to be more lenient.
There is one safe bet out of this, which is prolonged weakness for sterling and the euro, already near their lows for the year. When their central banks appear so much more dovish than the Fed, this can only weaken them against the dollar.
A second, slightly less safe bet is on European equities. Easy money is good for stocks, and these announcements will prop up stock markets which in Europe have been anaemic.
But there are provisos. In the UK, the great concern is the country’s bubble-prone housing market.
Adding stimulus when house prices are already high – and they are at extreme levels in London, if not the rest of the country – is a really bad idea. A weak economy and a housing bubble do not go well together.
In the eurozone, the issue is the resolution of the sovereign debt crisis, which has been in abeyance since the ECB’s promise last July to do “whatever it takes” to save the euro. But this promise does not resolve two critical issues. First, banks hold huge amounts of their own governments’ debt.
This link has to be severed, by agreeing ways to rescue banks that do not put pressure on public finances. That presumably means losses for banks’ creditors. Negotiations towards a “banking union” are tasked with resolving this, and they are tortuous.
Second, markets must be convinced that the credit of one eurozone country is as good as that of another. That means that countries must be prepared to stand behind each other, opening the prospect of expense for countries like Germany and of loss of sovereignty for those that might need help, like Portugal. It is an acute political problem.