Sunday, January 25, 2015
Near-zero rates and QE look to be here to stay
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

It has been a big week for monetary policy, led of course by the European Central Bank’s €1 trillion-plus quantitative easing (QE) programme but also here, with the two hawks on the Bank of England’s monetary policy committee having unexpectedly flown into the dovish nest.

The only big central bank that seems to be on track to raise interest rates this year is the Federal Reserve, with the markets expecting a move from the summer onwards. Even that may be a movable feast, however. On Wednesday the Bank of Canada, admittedly managing monetary policy in an economy vulnerable to oil price falls, surprised markets by cutting its main interest rate from 1% to 0.75%.

If you needed evidence that we are in a highly unusual period for monetary policy, there has been plenty of it in the past few days. This is becoming the near-zero decade for interest rates, even leaving aside the unusual and controversial tool of QE. Not since the period covering the 1930s, the Second World War and the few years after it have we seen anything like it, and Bank rate was higher back then than today’s 0.5%. And we did not have QE.

Will we ever see the return to anything like normal as far as monetary policy is concerned? Let me start with the European Central Bank’s QE “bazooka”, before coming closer to home.

There are a few things you need to know about eurozone QE, announced on Thursday by the ECB president Mario Draghi. The headline announcement of €60bn (£45bn) a month of asset purchases from March until at least September next year was a bit bigger than the markets were expected. The total size of the programme announced is €1.08 trillion, but about a third of that will be in assets other than eurozone government bonds, mainly private assets such as covered bonds and asset-backed securities.

Only 20% of the programme is what you might call unconstrained or pure QE, in which Europe collectively covers the losses if the assets bought fall below their purchase price. The rest will be undertaken by national central banks and any losses will be the responsibility of the taxpayers of the countries concerned. This was to meet German concerns that the citizens of Hamburg or Heidelberg should not be responsible for losses on Italian or Spanish bonds.

Will it work? It goes without saying that the eurozone’s problems go deep, and that supply-side reforms. Including more flexible markets, are essential, as well as infrastructure investment and growth-friendly tax policies. It may be that no amount of QE can rescue a flawed system.

Eurozone QE is late, six years after America and Britain, and is not as big as it looks. The bazooka is roughly twice the size of the UK’s QE programme but for a eurozone economy five times the size. “Too little, too late” – and compromised - was what characterised Japan’s QE programme in the early 2000s. The risk, as with other things, is that Europe repeats Japan’s experience.

I would not be entirely negative. The announcement of QE has pushed down the euro, which will help eurozone exporters. In a short time Draghi has established a reputation for pulling the eurozone back from the brink. Eurozone QE is a necessary but not sufficient condition for making things better. The question is whether there is rapid follow-through on the other necessary things.

What about Britain, where the latest developments were more of a hand-gun than a bazooka? The news last week was that the two rate-hikers on the Bank’s monetary policy committee (MPC), Martin Weale and Ian McCafferty, who from August to December last year had been voting to increase the cost of borrowing, this month changed their view.

Having previously argued that the MPC should “look through” the temporary weakness in inflation caused by falling oil and commodity prices, the scale of those falls finally persuaded the two to blink. With Bank staff saying it is 50-50 whether inflation, currently 0.5%, goes negative at some stage in the coming months, they feared that raising rates now could lock Britain into permanently very low inflation; well below the 2% target. They have not necessarily become doves for ever, but it is hard to see either voting for higher interest rates for many months.

It means that, as we approach the sixth anniversary of 0.5% Bank rate in March, there can be no solid expectation that we will see a hike this side of the seventh, in March 2016. Some analysts have already stretched out their expectations until 2017. Near-zero starts to look like the new norm.

Those who follow what the Bank does are entitled to be a little puzzled. Less than 18 months ago Mark Carney, its governor, set out his original forward guidance on rates. This was that the MPC would consider rate hikes when the unemployment rate, then 7.8%, fell to 7%, which the Bank did not then expect to happen until 2016.

Well 7% has come and gone. The latest figures, also out last week, show unemployment has dropped to 5.8%. Job vacancies, at 700,000, are at a record level. Pay growth is picking up, which at a time of very low inflation is translating into real wage increases.

True, there is tentative evidence that job creation has slowed from its previous breakneck pace. Yet this is, by any measure, a labour market which is tightening, alongside an MPC which has become more dovish. To the extent that we were being guided by the governor, we were being guided in the wrong direction.

Would I be raising rates now? No. But there have been times over the past few years when I would have done, notably when inflation was above-target. Had it been premature to do so, at least it would have established the principle that rates can go up as well as stay low. Rates would have risen to a level at which they could have been cut. As it is, the longer they stay the same, the higher the hurdle for a move. As things stand, the circumstances in which the MPC would raise rates are hard to see. High inflation did not do it and neither did strong growth. Very low inflation rules it out.

Though most of the attention has been on Europe, the likely delay in any interest rate increase has implications for the Bank’s £375bn QE programme. I do not think we will get more QE from the Bank but until rates begin to rise it will continue to reinvest the proceeds of any of the maturing gilts (government bonds) in its portfolio. Until rates have risen quite a lot, to a level from which they can “materially” be cut. QE, like near-zero rates, looks to be here to stay.