More quantitative easing needed to meet central bank policy targets, expert believes

News - Banking

Written by Ray Clancy

Monday, 22 November 2010 09:14

The global economic recovery is still too muted to create inflation pressures in many countries and significantly more quantitative easing would be required to meet central bank policy targets, it is claimed.

Global fund manager Standard Life Investments argues that to change inflation expectations permanently a much larger monetary response is needed from the US and Western authorities than that already announced.
This is based on research by Standard Life Investments that shows that inflation will stay low in the short and medium term because of sizeable excess capacity in developed economies, leading to GDP growth that in many countries is uncomfortably weak for this stage of the business cycle.

‘In the short run disinflationary forces in western economies, especially the US, appear too powerful to be overwhelmed by the recent loosening of monetary policy which is unlikely to boost economic capacity. Additionally, the chance of any further fiscal loosening appears constrained by the ballooning of national budget deficits. This suggests the policy response in the short term is unlikely to cause inflation,’ said Richard Batty, global investment strategist at Standard Life Investments

Further concerns relate to future demand for credit as banks and consumers continue to reduce their levels of leverage. He points out that regulatory reform via Basel III also means higher capital levels for banks and hence less ability to create new credit.

Writing in the latest edition of Global Perspectives he also says that US mortgage demand has already decelerated in recent years for any given level of interest rates. In the UK, recent
mortgage lending data has been a small fraction of that being lent just three or four years ago.

‘This is evidence that mortgage holders are becoming less sensitive to the level of mortgage rates. All in all, it may be doubtful that further QE will materially help the housing or borrowing markets while consumers worry about negative housing equity or the state of the jobs market,’ he points out.

And he says that fiscal and currency headwinds are also important to consider. ‘One of the less helpful consequences of further monetary loosening via a falling US dollar has been the recent 10% rise in the oil price. If sustained, this would, de facto, be a “tax” on growth in the longer term. Of course, the flipside of a weaker US dollar is stronger profits growth for certain US companies, although this has a limited economy wide impact. Stronger currencies elsewhere, for example, the yen and the euro as the result of the declining dollar, are another global growth headwind,’ he explains.

‘Additionally, fiscal retrenchment, especially in Europe, may also knock 0.5% to 1% off GDP each year, again keeping output gaps wide. Persistently large output gaps, when they have occurred through history, have meant little subsequent upside risk for inflation, due to stubbornly high unemployment and moderating nominal wage growth,’ he adds.

‘To change inflation expectations permanently, we believe that a much larger monetary response would be needed from the US and Western authorities than that already announced. In summary, if central bankers decide that higher inflation must be engineered, then investors should anticipate another phase of extraordinary policy measures through QE3,’ he explained.