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Economics Weekly - Is it too soon to start withdrawing QE? Weekly economic data preview - Pre-Budget Report to dominate a particularly busy week for UK data

Economics Weekly - 7 December 2009

 

Is it too soon to start withdrawing QE?

 

Quantitative Easing (QE), the purchase of private and public sector debt by the central bank financed by an expansion of its balance sheet, has been in place in the UK since March. Similar policies are also in place in other countries. There appears to be a difference of opinion about whether QE is working or not. Most agree that it has been essential in preventing a financial collapse in early 2009, and in the immediate aftermath of the failure of Lehman Brothers on 16 September 2008. This is not just true for the UK, however. Injections of liquidity (cash) into financial markets by central banks in many other countries were also essential in staving off a global financial calamity.

 

Now that financial markets have staged a recovery and economic conditions have strengthened, there are those who argue that QE and liquidity injections generally should be withdrawn to avoid another asset price bubble and because they have succeeded in boosting economic growth. Comments from some members of the UK Monetary Policy Committee (MPC) seem to suggest that there is support for this thesis. But is it true that QE has succeeded on all fronts, boosting money supply and kick-starting a sustainable economic recovery? We look at some of the issues in assessing whether QE has succeeded.

 

Taking the UK as an example, QE started in March 2009, when liquidity appeared to be drying up in the financial markets and policy interest rates were cut to record lows. Businesses in the financial, corporate and personal sectors could not get hold of money at almost any price. This led the central bank to take the decision to directly inject money into the financial sector by buying up gilts and other private sector bonds so that market participants and hence their customers did not fall short of the liquidity required to keep operating. Chart a shows that since then gilts yields have stabilised and equities have recovered. In this sense, QE seems to have worked. It has stabilised financial markets and sparked a recovery in asset prices. Corporate spreads have narrowed sharply; money market interest rates and spreads have also come down substantially. In the absence of QE, company insolvencies would have been higher, debt defaults greater, and personal debt, bankruptcy and unemployment much more than otherwise.

 

As chart a confirms ,financial markets have recovered since QE started and appear firmly on the mend. Money from central banks’ purchases has found its way into corporate bonds, the stock market, commodities and a range of financial market assets. This improvement in markets has helped companies to refinance themselves at cheaper costs than otherwise, as rising prices for bonds and equities lower the cost of capital. Chart b shows the extent to which companies in the UK have been using capital markets for finance. Since March, there has been a pronounced use of equity and bond issuance to raise finance. Also, continued low interest rates mean that households have more money in their pockets to spend and that has helped to maintain consumer spending and retail sales. This means that global economic growth has turned and recovery is underway. True, the UK economic recovery is lagging that in some other countries, with the US, eurozone and Japan already out of the recession. Emerging market countries have recovered fastest of all. But UK economic recovery now appears likely in Q4. On this thesis, QE has done its job. The path to economic recovery may not be smooth but it should be unstoppable. Hence, QE should be withdrawn before it becomes inflationary.

 

There are a couple of important problems with this argument, however. One is that the quantity of money is still falling sharply. And not just in the UK, but in the US and euro area as well. Charts c and d show nominal (inflation plus volume) economic growth alongside money supply growth. If QE was working so successfully, why is money supply contracting? It begs the question of whether there can be a sustainable economic recovery when money supply is shrinking in this way. Many would argue that it is not possible. Not all would agree, however, as the economy may simply settle at a lower level of activity and growth still occur. But if money supply is still contracting in February 2010 when the current allocation of QE is used up, will the MPC really stop purchasing securities from the private sector?

 

A second major issue is that households and companies are severely cutting back on borrowing or are repaying debt outright. This means that economic growth from investment and household consumption will remain weak, perhaps threatening economic recovery. The next series of charts, e, f and g show this trend occurring in the US, UK and eurozone economies, posing a challenge to policy makers in these countries. Do they withdraw the extraordinary policy measures put in place to inject liquidity into the economy, and keep down the costs of borrowing and servicing debt, when economic growth appears so fragile? At present, this still seems a delicately poised decision. It is not one that leads to the certainty that policy loosening will be withdrawn in short order. Signs of economic recovery currently being seen might start to wither if monetary policy  tightened too soon.

Trevor Williams, Chief Economist, Corporate

 

Editorial comments to:

Trevor Williams

Chief Economist

Lloyds TSB Corporate Markets

Economic Research

10 Gresham Street

London, EC2V 7AE

Tel: +44 (0)20 7158 1748

 

Weekly economic data preview - 7 December 2009

 

Pre-Budget Report to dominate a particularly busy week for UK data

 

􀂄 This week sees a particularly busy calendar in the UK, featuring the Chancellor’s Pre-Budget Report (PBR) and the latest Monetary Policy Committee (MPC) meeting. We look for Bank Rate to remain on hold at 0.5% while the MPC continues with its £200bn programme of asset purchases. The PBR, meanwhile, will be closely-watched as markets focus on government efforts to consolidate the public finances. Elsewhere, there is no shortage of economic data and events taking place in the US. Here, the main highlights include October trade data, latest weekly jobless claims figures, November retail sales and December’s preliminary Michigan consumer confidence survey. Following last week’s ECB monetary policy deliberations, the euro-zone sees a somewhat quieter week in terms of economic data. With little in the way of aggregate euro-zone data scheduled for release, attention this week turns instead to German, French and Italian industrial production figures.

 

􀂄 With UK monetary policy decisions currently being made on the basis of fiscal policy formulated back in April’s Budget, this week’s PBR will be among the most closely watched in years. If the Treasury’s PSNB projection for 2009/10 of £175bn looked bad in April, recent monthly data on the public sector finances suggest it could look even worse come Wednesday. Clearly, the bigger picture is how to achieve the goal embodied in the recent Fiscal Responsibility Bill – of halving the fiscal deficit within four years. On the revenue side, much of the build-up to the PBR has centred on a prospective increase in taxation for high earners. Possibilities include a widening in the scope of the new 50p top rate of income tax, increasing National Insurance contributions for top rate taxpayers and also various measures to boost revenue via the Inheritance Tax system. In terms of spending, numerous government departments are likely to see budgets pared back significantly compared with the growth seen in previous years. While the PBR is likely to dominate events in the UK this week December’s MPC meeting will, as ever, be carefully watched by financial markets. We look for Bank Rate to remain on hold at 0.5% while the £200bn programme of asset purchases – aimed at boosting nominal economic activity in the economy - continues. Importantly, October UK industrial production data are released this week, where we look for a 0.4% month-on-month increase. But the figures take on added significance, since the October data will provide a guide to Q4 gdp.

 

􀂄 In the US, ahead of the next FOMC meeting on 16 December, this week features a wave of important economic data including trade, retail sales, initial jobless claims and December’s preliminary University of Michigan consumer confidence survey. We look for the US trade deficit to narrow to $32bn in October, in part reflecting US dollar weakness. Meanwhile, last week’s better-than-expected non farm payrolls figures have prompted a more optimistic mood in terms of labour market prospects. We think that this Thursday’s (less high-profile) data on initial jobless claims will show a small (7k) decline, so keeping the four-week moving average on the downward path seen since March. Retail sales figures for November are published on Friday, where we look for a 0.5% m/m rise in the exautos measure. If realised, this would be the fourth consecutive month-on-month increase. But household balance sheet adjustment, continuing job losses and the recent expiry of the so-called ‘cash-for-clunkers’ incentive scheme does not augur particularly well for consumer activity heading into 2010.

 

􀂄 There are relatively few euro-zone economic statistics scheduled for publication this week, so attention will shift to various national indicators. Industrial production figures for Germany, France and Italy are all due for release. In Germany, we look for industrial production to rise by 1.2% in October, with robust demand for investment goods as global economic recovery continues, led by emerging Asia. In France and Italy, we also envisage significant month-on-month rebounds in industrial output, of 0.6% and 1.7%, respectively.

Mark Miller, Global Macroeconomist

 

 

Economic Research,
Lloyds TSB Corporate
Markets,
10 Gresham Street,
London EC2V 7AE
,
Switchboard:
0207 626 - 1500
www.lloydstsb.com/corporatemarkets

 

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