Its fashionable for central banks to be more cautious in the West. The Federal Reserve is busy putting up interest rates. Many forecast a move up from 2% to 2.5% this year and a further move to 3.25% next year. Meanwhile, the US central bank is also reducing its own balance sheet as the Treasury bonds it owns are repaid by the state. In the Eurozone, the European Central Bank (ECB) is gradually cutting back on the amount of quantitative easing it undertakes each month, with the expressed intention of stopping it altogether by the end of this year. In the UK, the Bank of England (BoE) has put up rates once, has withdrawn special facilities for the clearing banks, ended quantitative easing and announced a tougher climate for various kinds of consumer credit.
The East is not taking such a firm line. Japan continues with large amounts of quantitative easing and not a single interest rate rise in sight. Despite years of attempted easy money with zero interest rates and plenty of central bank money creation, there are no signs of inflation causing trouble. China is experiencing a monetary slowdown, so her most recent action was to lower the reserve requirement it places on commercial banks to allow them to lend more for any given amount of capital they hold. Money growth in India is quite fast after the disruption to the system from the bank note reform.
The world economy as a whole is growing at a reasonable pace, and will be sustained this year by Chinese and US growth in particular. The Chinese authorities are conscious that money growth has slowed and look as if they will take offsetting action if they fear economic growth falling below 6%. The US authorities reckon the US economy will perform well this year and next, thanks in no small measure to the large fiscal stimulus being applied by the Presidents tax cuts and the Congress budget which has increased spending in many areas. The Fed has said it will only carry on raising rates if the real economy continues to do well. Money growth is around 8% in China and around 4% in the euro area and the US.
This does not mean we can ignore the US tightening. It may continue to exert upward pressure on the dollar, as more people come to want to hold dollars for the higher interest rates available. This will put some stress into the more exposed emerging-market economies that have large dollar debts. Coupled with the US Administrations aggressive stance on trade matters, there will be some adverse effects on world growth.
The Eurozone is a more difficult situation. Germany and the other northern creditor nations have economies that are performing well and wish to end the special monetary measures the zone has been taking. The ECB now owns €2.4 trillion of bonds, largely issued by member states governments. Italian state debt is more than 14% of the total, and Spanish and Portuguese debt a combined 11.5%. Germany wants the ECB to end its purchase programmes, afraid that it is putting off economic and budget adjustments in the weaker countries. The new Italian government has implied that, whilst it wishes to stay in the euro, it wants to exceed the budget-deficit limits and detach itself from various financial disciplines of the zone. This could cause turbulence in the banking system and markets, and make ending all quantitative easing a tougher policy than planned. There are likely to be market reactions to little or no quantitative easing, and worse reactions again if the Italian challenge becomes too noisy.
The UK authorities are undertaking a monetary tightening which has nothing to do with Brexit. The BoE decided to end quantitative easing and to put up rates by 0.25%, judging the economy strong enough to take this. It has also decided to end the special loan facilities for commercial banks through its Term Funding Scheme. Banks had borrowed £127bn of cheap finance under this by April 2018 to lend on in the UK economy. It has announced a higher Counter Cyclical Buffer Rate of 1% from November 2018. This will restrict lending commercial banks can do, requiring them to keep more capital for any given quantity of loans. It has introduced “prudent affordability criteria” and limits on mortgages that are more than 4.5 times salary to curb house purchase and price rises. It has warned banks against overuse of promotional zero percent rates on credit cards. It has required banks to be more pessimistic about future values of cars for any car loan advanced, with tough warnings on personal contract purchases of cars which had been growing rapidly. As the BoE said: “The recent actions by the Financial Policy Committee and the Prudential Regulation Committee were expected to result in some further tightening in consumer credit conditions”. In the light of all this it is not surprising that the UK economy has slowed markedly. There are no signs that the BoE wishes to relax any of this to stimulate more output. Its actions to slow the housing and car markets have been reinforced by government higher taxes on housing transactions and more expensive vehicles.
Overall, there is sufficient monetary tightening in the world to limit inflationary pressures and to act as a brake to world growth. We still think the world will grow at more than 3% this year, but it is less likely now that the growth will accelerate. Even though there is a substantial fiscal stimulus in the US with the added bonus of repatriation of company profits to spend at home following tax changes, the monetary headwinds and trade issues act against the US performing even more strongly. Meanwhile the uncertainties in the Eurozone coincide with a slower growth period for them, whilst Japan is still not triggering the burst in inflation and output it has been seeking for years. Slowing money has slowed some share markets. Going forward it reminds us how far shares have climbed in recent years on the back of easy money. From here it will take the better profits, dividends and share buy backs we are expecting to make more progress. For the time being, we prefer the US to the Eurozone, where there is a better outlook for sustained growth and less currency and banking risk.
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