To QE or not to QE, that is the question

Ahead of the Federal Reserve’s 2011 annual conference, MRM’s Charlotte Banks looks at the role of QE and how it affects the market

Federal Reserve chairman Ben Bernanke, will deliver a speech at the Fed’s annual conference in Jackson Hole. This will hopefully end months of speculation about whether the US will be partaking in another round of quantitative easing (QE), or at least give the world an idea of what it intends to do about the economic crisis.

Over the last few weeks the industry has been debating whether there should be more QE through bond buying. This will hopefully boost the money supply in the economy as the normal process of cutting interest rates is not working.

Generally, lower interest rates encourage people to spend money and not save it. However, it is clear that this is not happening at the moment. Consumers are not spending money and companies are also hoarding cash. An article in the Telegraph today reveals that Nationwide’s Consumer Confidence Index confidence fell last month and is likely to continue falling in August.

Seeing as interest rates are already at a historical low of 0.5% and are unlikely to go lower, the Bank of England (BoE) has the option to pump money into the economy directly. This is done by buying assets such as government or corporate bonds. The thought process behind this is that by buying bonds the BoE is reducing the supply of bonds therefore increasing the demand for new bonds and making it cheaper for companies to borrow money.

Looking back on previous attempts at QE there have been numerous debates on whether this is effective or not. Chris Bowie, manager of the Ignis Corporate Bond fund, says not everything about QE has worked.

“QE has had a distortionary effect on consumer prices and hasn’t always been beneficial for consumers,” he says.

He also points out that as inflation has remained high in the UK and the US, and commodity prices have been significantly higher, it is hard to see what the effects of QE have been.

However, on the other hand, Bowie says QE has partly worked in the sense that asset markets were supported whilst it took place.

It is hard to say whether Bernanke will announce details of further QE in his speech tomorrow. It is widely known that he signalled the start of QE at the 2010 annual conference, but whether he will repeat this trick remains a mystery. Markets have already begun to factor in the possibility of further QE and as a result have risen, albeit marginally, on the hopes of further stimulus.

In a comment piece this week, Stuart Thomson, chief economist at Ignis Asset Management said that QE3 is not likely in the near-term, but believes the Fed will be forced to pursue additional QE during 2012. He also said the key question is whether the UK will lead or follow the US.

“We believe that the UK should pursue QE before the Fed, because fiscal austerity is more acute in the UK and the requirement for loose monetary policy to offset this economic squeeze is consequently more pressing. But we are acutely aware of the difference between prescription and description,” he said.

Martin Bamford, managing director at IFA firm Informed Choice, thinks it is unlikely Bernanke will announce specific details of QE3 in his speech, but says he is likely to provide some positive clues about the future of monetary policy in the US.

With regards to a further round of QE in the US, Bamford says this is probably needed, on balance, to ensure their economy does not return to what would be a damaging recession.

“Given the importance of the US to world economic recovery, decisions made by US policy makers can have a direct impact on all of us.

“In the UK, the Bank of England is carefully balancing interest rates, price inflation and economic recovery.  They are doing the sensible thing at the moment by keeping additional QE in reserve.  Pumping more money into the markets would stimulate the economy, but it could also result in much higher than tolerable price inflation and then a need to hike interest rates which would crush chances of a sustained economic recovery,” he concludes.