Markets need to know more about how the major economies are going to end printing money and curb their large public deficits. This week on both sides of the Atlantic there were hints that the current programmes of quantitative easing - printing money - will be the end of it. Both the Fed’s statement and the Governor of the Bank of England implied that the existing sums pledged will be enough in their view.
In the UK the Governor also attacked the government’s public spending and tax plans.
“We are confronted with a situation where the scale of the deficits is truly extraordinary. This reflects the scale of the global downturn, but it also reflects the fact that we came into this crisis with fiscal policy on a path which wasn’t sustainable and a correction was needed”, he said.
The Governor is proving to be a shrewder politician than he has been a central banker. He may have misread the cycle badly, allowing too much money in 2003-6 and too little in 2007-8, but he is reading the political cycle well. He may have kept interest rates too low in the early years of this decade, and pushed them too high thereafter, but he now wants some sea room between himself and Gordon Brown’s tripartite regulatory regime. He understands the forces that now are pushing us to lower public spending after the next Election, and realises that the special measures taken to ensure the sale of enough gilts this year may not be possible again thereafter. He is siding with the Chancellor and the Leader of the Opposition against the Prime Minister, and is even daring to criticise the PM for the size of the deficit he built up as Chancellor in the “good times” before the crash.
The Governor revealed this week that the Bank was not properly consulted on changes to the regulatory regime for banks, and has sent his warning shot about the deficit. We need a unified command at the Bank, capable of regulating the main banks, handling the government debt issue and organising the money markets as the Bank did before the 1997 policy changes. In the short term it will be more of the same – strengthened powers for the FSA to control banks, resulting in demands for them to buy more gilts and hold more liquidity.
Share and commodity markets have run up rapidly in the second quarter of 2009 on the back of easy money and low interest rates. We have been expecting a pause and some reconsideration of prospects. If it is the case that we are near the end of the UK’s quantitative easing, and the US programme is not going to be expanded, then we would expect the doubts in the both the UK and US to set in more. Neither government has a clear plan on how to return from mega deficits to more normal public finances. Both face the task of selling ever larger quantities of government debt. That will mean higher interest rates.
The ECB is attempting to loosen its banking and money markets, responding later to the recessionary pressures than the UK and US authorities have done. Manufacturing remains very short of orders, despite the big destocking which has occurred.
The latest OECD forecasts may prove too pessimistic, as they have revised down their growth figures further for most economies. We continue to favour Asia more than Western share markets, and will invest more of the cash we have accumulated for clients in recent weeks when we see suitably priced opportunities.