Which Central Bank Is the Most Likely to Restart Quantitative Easing?

 | Aug 23, 2017 | 8:00 AM EDT
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There is a subtle fight taking place between world central banks, but don't expect to hear a word about it at the Jackson Hole meeting this week. That fight is about increasing -- or at least maintaining -- public trust. In a world of fiat currencies, credibility is the new gold.

This is why there is all this talk now about exiting, winding down and tapering of asset purchases. Central banks that keep buying their countries' own bonds -- as well as other assets, such as equities in the case of the Bank of Japan, corporate bonds for the Bank of England and the European Central Bank, and mortgage-backed securities for the Federal Reserve -- cannot do so indefinitely. People will see through the ruse, eventually.

Of course, the prevailing wisdom is that a weak currency is good for exports. Up to a point, it may be. But it depends how weak, and it also depends how good that country is at exporting stuff in the first place. Just look at Zimbabwe. A weak currency didn't help there.

So, major central banks must project credibility in order to gradually shift the burden of buying bonds back to the private sector, where it belongs. Some are in better positions than others.

The Fed, which was the first of the large Western central banks to print money after the financial crisis hit (the Bank of Japan was printing well before that), is the most advanced. It stopped buying bonds, it is raising interest rates, and it has an exit plan.

If you think the one that is most behind is the ECB, which still is buying public and corporate bonds and has not announced any plans for winding down these purchases, you might be wrong. Even though the Bank of England stopped its bond purchases a while ago and only reinvests the proceeds of quantitative easing, it could find itself forced to restart them at some point in the future.

For the moment, it doesn't look like that will be the case. U.K. government finances posted a surplus in July for the first time in 15 years, and public sector net borrowing actually decreased in the fiscal year that ended in March 2017 versus the fiscal year that ended in March 2016. It was the lowest budget deficit in nine years.

But this is where the good news ends. As the country leaves the European Union, the U.K. government will need to ramp up spending in future years in order to replace EU funds that benefited various industries. Farmers, for instance, were receiving EU subsidies, and the government has promised the car industry that nothing will change after Brexit.

It is true the country will benefit from not needing to send money to Brussels, but there is the issue of residual payments for projects to which Britain has committed; those payments are estimated anywhere from €40 billion ($47 billion) to €100 billion.

Cutting spending elsewhere will not work. The housing sector, especially homebuilders, has come to depend heavily on the government's Help to Buy program, which provides equity loans valued at 40% of the home price in London and 20% outside to buyers of newly built properties. This has helped homebuilders to hike new-home prices significantly.

Welfare spending will need to increase, if -- or rather, when -- jobs go because of Brexit. Unemployment is at a multiyear low now, but a survey of 601 employers released on Wednesday, Aug. 23, by the Recruitment and Employment Confederation (REC) showed confidence has weakened.

Banks already are shifting jobs elsewhere in the EU in anticipation of Brexit, with about 10,000 positions moving in the coming years, according to various reports. While it does not sound like a lot at first, the number can swell further as uncertainty over Brexit continues.

Besides, these high-paying jobs support others, such as nannies, catering staff and hairdressers, who may suffer if their wealthy customers go. The government will need to step in with welfare measures to help those who lost their jobs, not just in the form of unemployment benefits but also in other ways such as the housing benefit.

Meanwhile, in a world of slowly rising interest rates, bond investors will be pickier. Due to the ECB's massive purchases, eurozone debt has become attractive. There are fears that the ECB will start winding down its bond buying soon, but the strong euro is offering some respite as it lowers inflation.

Therefore, U.K. government bonds -- or gilts, as they are known -- have some serious competition. With the pound almost at an eight-year low versus the euro and unlikely to rebound strongly soon, the bonds' attractiveness is waning fast. The Bank of England owns £434.7 billion of gilts -- that's about 28% of the total government debt outstanding. There's still room for it to buy more, and if the government loses credibility so much that investors bail out of gilts, it just may need to do so.

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