The great experiment called QE is about reducing leverage through the devaluation of money. The main thrust is to make sure that real interest rates are negative throughout the curve. This favours borrowers over investors. What’s frustrating for the central bank is that monetary policy appears to be nearing its limits. Enter the next phase, broadcasting the fact that negative rates are here to stay. Market stability and confidence are improved by certainly of intention and we reach “escape velocity”. A consistent medium term policy stance is helpful but the problem with this message is it’s asymmetric. We just hear that it’s more of the same. The best made plans (especially in economics) have a habit of failing to ignite. So what happens then? We just don’t know. The Bank intends to anchor rates low. But what would happen if any of the following events (which have occurred to the UK economy at least once since 1970) happened again?
UK credit deteriorates badly;
The US comes out of recession fast and hikes rates;
Sterling collapses;
UK inflation takes hold. Does the planned policy continue? Hardly, these scenarios aren’t mutually exclusive and if the central bank decides to target rates it will lose control of other variables. Political considerations would force change. QE would end but how we don’t know. Convincing markets (and consumers) that a retro rocket exists that could be fired should we need to jettison QE would go a long way to improving confidence. Unfortunately on this mission the engineers seemed to have overlooked this. Let’s hope “escape velocity” isn’t terminal.
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