Bank of England’s Juggling Act Gets Ever Riskier

The length of time monetary policy is spending at emergency settings raises concern

By Richard Barley

No disappointment. Unlike other central banks, the Bank of England on Thursday overwhelmed markets by pulling every stimulus lever available to counteract the shock of Brexit—and making clear they could yet be pulled harder. This effort, while prudent for now, is further exposing the risks of aggressive monetary policy.

Gov. Mark Carney and his colleagues certainly weren’t timid. The BOE cut rates by a quarter percentage point to a record low 0.25%, with a further cut possible, although Mr. Carney made clear that negative rates weren’t on the cards. It launched a new program to provide up to £100 billion ($133.25 billion) of cheap funding to banks to support lending and reduce concerns about squeezed margins. And it announced plans to buy another £60 billion of gilts, taking its holdings to £435 billion, topped off with £10 billion of investment-grade corporate-bond purchases.

Markets had priced in easing, but not such a big-bang approach. Sterling fell more than two cents against the dollar, 10-year gilt yields hit a new record low, the FTSE 100 rose and sterling corporate bonds rallied.

There are two trade-offs the BOE is juggling here. The first is a traditional one for central banks: growth versus inflation. The answer here is easy—the BOE is right to focus on growth and overlook a possible rise in inflation. The bank lowered its forecast for growth by the largest amount ever, showing the economy crawling through the next 18 months. Despite the weakness, the bank does forecast a jump in inflation. But that is due to the steep fall in sterling, which will push up import prices.

The second is much trickier: the trade-off between growth and financial stability. Globally loose monetary policy has already raised many worries about distorted markets. Mr. Carney repeated the mantra that bond purchases would push investors to take more risk. But this process risks inflating bubbles as the search for yield has already pushed bond prices sky-high and led investors to embrace riskier assets such as emerging markets and high-yield bonds. In the process, it has made the outlook for future returns poorer.

The BOE’s bank funding measure is more evidence of the risks that central banks are adding to the financial system. Low rates squeeze bank margins and hurt profits, making banks look weaker. Investors have sold off bank shares in part because of that weakness. And there is some evidence that low stock prices can make banks less likely to lend. The BOE plan is designed to offset that risk by giving banks cheap funding if they maintain or increase lending.

Mr. Carney insisted that the positive effects of the stimulus outweighed the risks to financial stability, but the plan to aid banks makes it clear he’s aware of the risks.

That judgment may be right in the short term. But increasingly, it is not just that monetary policy is at emergency settings, but the length of time that it is continuing to spend there that is raising concerns.

Markets have had a sugar rush from the BOE’s policy action, but doubts about the long-term effects of policy makers’ actions just got a boost too.

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