Faith in monetary policy weakening

Policymakers are running out of tools with which to fight another downturn

Faith in monetary policy weakening

Tony Ward is chief executive of Clayton Euro Risk

A report from Moody’s this week gave cause for concern. It warned that the world's biggest economies risk being sucked into a negative spiral of low growth and falling investment as market fears about global recovery become ‘self-fulfilling’. The ratings agency expects the G20 countries to grow by just 2.6% this year and 2.9% the next, as it reduced its oil price forecast. Prices, it said, were unlikely to climb above $40 per barrel by the end of 2017.

2016 has not got off to the best of starts. World stock markets are in bear territory; gold – a safe haven in times of turmoil – has had its best start to a year in almost a decade, and the cost of insurance against bank default has surged. Banks’ share prices have tumbled due to concern about their ability to withstand weakening growth and negative interest rates. Worryingly, talk of recession in America is growing louder: the Federal Reserve has got the jitters with chairwoman, Janet Yellen, warning that growth in the US economy could be hurt by global conditions, citing the economic slowdown in China and other emerging nations as a ‘drag on the US economy’.

Moody's warned that downside risks to growth have increased markedly over recent months and suggested market turmoil could spill into the wider economy. ‘Investors may start to price in the possibility of lower economic growth and returns, which could become partly 'self-fulfilling' via negative wealth effects and tighter financing conditions,’ it reported. ‘The impact on the global economy would be amplified if losses on trading portfolios and financial assets more generally led banks to tighten credit standards.’

This really concerns me: the one thing investors like is certainty. Confidence is all. I agree also with Moody’s view that policymakers are running out of tools with which to fight another downturn. The ratings agency said: ‘Where government budgets are hit by lower commodity prices and depreciating currencies fuel inflation, room to mitigate the downside risks is limited.’

I suggest that this one fear above all casts a shadow over the markets; that our arsenal of weapons against economic weakness is no longer effective.

This message was reiterated by the Organisation for Economic Co-operation and Development (OECD), which is calling for urgent action by world leaders to tackle slowing growth. It said that cutting interest rates and other monetary policy fixes were insufficient to create reflation. In Europe, Japan and Switzerland, rates have been cut to negative. However the OECD said: ‘Monetary policy cannot work alone. A stronger collective policy response is needed to strengthen demand.’

I agree: faith in monetary policy is weakening and negative interest rates in Europe and Japan may not be the answer as they just make investors nervous about bank earnings. This anxiety then sends share prices lower. And I’m not sure if more quantitative easing will do the job either.

The OECD recommends that governments take advantage of low borrowing rates to invest. ‘With governments in many countries able to very low interest rates, there is room for fiscal expansion to strengthen demand in a manner consistent with fiscal sustainability’ the OECD said. ‘The focus should be on policies with strong short-run benefits that also contribute to long-term growth. A commitment to raising public investment would boost demand and help support future growth.’

Maybe it’s time for politicians to become involved and for fiscal and monetary policy to work hand-in-hand. G20 finance ministers and central bankers including George Osborne and Mark Carney will meet in Shanghai on Friday and Saturday. Treasury officials have suggested that the meeting of leading economic influencers would be an opportunity to take stock of the global financial climate. Let’s hope for some innovative ideas that bring confidence back to the markets.