To QE or not to QE

Big central banks have become less inclined to QE…

Recently, the minutes of the March MPC meeting at the Bank of England showed that only one member now favours more QE and he even said that the call was finely balanced. That was a surprise for us as well as for most other market observers, and an increase in the asset purchase programme is no longer on the agenda, at least for the May meeting. Maybe it should not have been a surprise given that also the ECB and the Fed have sounded less inclined to QE recently. Senior ECB officials have talked about a higher bar for more direct bond buying (through the SMP) after the liquidity provisions (LTROs) and the Germans even want to start preparing an exit from QE. The Fed minutes suggested that the bar for more QE has been raised in the US as well.

Why this change? The main reason is probably that the tail risk of a complete meltdown in Europe has diminished after the LTROs. Even in the US, a meltdown in Europe was seen as the biggest downside risk to the economy. The underlying problems have not been fixed, but that was never the aim of central bank QE. QE has helped break the negative feedback loop from panicking markets that affected growth adversely and fed back to more market panic. QE has bought time for governments and banks to deleverage in an orderly fashion. With the economies now slowly recovering and markets functioning then it is time for politicians to do their part and central banks have turned out to be much less inclined to QE than expected.

… but may be forced back into the game

So no more QE? Well, as we recently reiterated, we still expect QE from the Fed in June. This is based on expectations that incoming data will push the Fed back into QE. We have doubts when it comes to Europe. In case incoming data start to worsen significantly then the ECB will obviously be ready to do more. There is no one else and the ECB has now taken the role as the ultimate back stopper. However, we doubt that key figures will really turn that bad in Europe (even after yesterday’s disappointing PMI numbers) and believe that the LTROs still have an underlying positive effect on the economies.

Event risks are the joker that could change economic sentiment. Elections are looming in France and Greece, the Netherlands has no government and the deadline for banks to meet higher capital requirements is nearing. It is not for the ECB to rescue specific member states, but market panic that affects economic sentiment would force the ECB to act.

So what do we actually believe? US key figures will surprise on the downside in the near term and force the Fed to embark on QE again in June. In our baseline, the ECB and now also the BoE are done with QE, as we expect gradual recoveries through the year. However, given the large number of serious event risks, it would not be a big surprise to see either central bank being forced back into the game of QE.

Still, we no longer expect the BoE to expand the asset purchase programme in May as a baseline scenario!

More on the Fed view: http://research.nordeamarkets.com/en/?p=4455

Anders

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