Central banks are stuck in a moment
You’ve got to get yourself together / You’ve got stuck in a moment / And now you can’t get out of it
Yes, those are U2 lyrics, and no, I’m not going to talk about the Irish rock band.
Some of my friends love U2, others hate them. I’ll leave a long discussion about their music for the pub!
Anyway, the chorus of Stuck In A Moment You Can’t Get Out Of reminded me of the predicament central banks currently find themselves in.
During the crisis they heavily intervened in the markets with a series of emergency measures to keep the system from imploding.
Nine years on, these emergency measures are still in place as central banks are only cautiously moving away from ultra-low interest rates and massive bond-buying programmes.
That’s because an end to those policies could have serious consequences for the economy.
Lots of companies rely on central bank stimulus, while higher interest rates could get borrowing households into trouble.
In other words, private and corporate debt is putting the economy at risk. It’s also limiting central banks’ room for manoeuvre as they seek to abandon their crisis policies.
Can central banks afford to “normalise” rates and curb quantitative easing? Can they afford not to?
Stuck in a moment
When US bank Lehman Brothers failed and the world got caught up in a financial crisis, central banks rushed to the rescue to do some damage control.
They did everything in their power to boost the money supply and get people spending.
First they cut interest rates, which has the effect of boosting the money supply; when rates hit zero they started printing money and using it to buy government debt.
Of course these measures were always intended to be temporary. Emergency policies for emergency circumstances.
Now it’s 2017 and the Bank of England’s Monetary Policy Committee most recently voted to keep interest rates at a historically low 0.25%.
It’s not just the Bank of England, of course. The European Central Bank is in the same boat.
Last week, ECB president Mario Draghi announced interest rates will remain unchanged while the end of the ECB’s stimulus programme is not yet in sight.
This is despite prominent central bankers repeatedly saying the financial system has become more robust.
Last month, Federal Reserve chairwoman Janet Yellen even went as far as to say another financial crisis is unlikely to happen “in our lifetime”.
That may mean something different coming from a 70-year-old, but still. Central bankers exude confidence, but their actions say something different.
If the system is truly in a good condition, what’s stopping central bankers from moving away from emergency policies?
And now you can’t get out of it
In public, central bankers are all calm and smiles. But in private they must be rather anxious, because Brits are now neck-deep in debt.
Banks and other business models may have become dependent on super-low interest rates.
“Like animals in captivity, companies incubated on the milk of QE and low rates may no longer exhibit the natural behaviours needed for success in the wild of a stimulus-free market,” fund manager Eoin Murray warns in the Telegraph.
There’s a threat there for investors. When rates go up, companies which depend on cheap borrowed money could run into trouble and shareholders could get burnt.
Again, Europe is no different.
Bank of America analysts have classified 9% of Europe’s biggest companies as “the walking dead” – meaning they could collapse as soon as they come off the ECB’s life support.
No wonder Draghi is treading carefully.
Meanwhile, a Bank of England official has sounded the alarm about banks making it easier for households to get credit.
Consumer credit has gone up by 10% in the past year. As a result, the Bank of England recently urged banks to hold more capital as they become more vulnerable now that more people could default on their loans.
As inflation outpaces wage growth, it could force more “just about managing” households into borrowing. More private debt will put even more pressure on the Bank of England to keep interest rates close to zero.
Later will be better?
That’s not what the Bank of England wants, though.
There are two reasons why the BoE wants everything back to normal. They’re inter-related.
The first reason is that the BoE wants some “bullets in the chamber”: it wants higher rates in order to be able to cut them again in times of crisis.
The second reason is that the BoE now owns hundreds of billions of pounds’ worth of government bonds, accumulated through years of printing money and buying bonds with the proceeds. And it wants rid.
The Bank isn’t comfortable owning the bonds of the government of which it’s a constituent part. That’s not how the system is meant to work.
If the government can issue debt, then have the Bank print money to buy it back… that’s not good. It sets a bad precedent.
So it’s clear interest rates will eventually have to go up. But the current levels of debt imply many households and businesses can barely keep their heads above water as it is.
How many of them will drown if central banks curb their bond-buying programme and hike interest rates?
Debt could be what’s keeping Mark Carney and Mario Draghi stuck in a moment they can’t get out of.