Never mind the rebound in economic growth, the rise of emerging markets, the advance of new technologies, or whether the euro survives or not. There is really only one thing that matters to stockmarkets right now: whether central banks will continue with quantitative easing (QE) and keep interest rates at record lows – or, if not, when they will stop printing money and get rates back to near-normal levels.
In Britain, that is meant to happen when the unemployment rate drops to 7%. In America the Federal Reserve has targeted a 6.5% jobless rate. But now the Bank of England is looking at rising real (after-inflation) wages as a trigger, while the Fed is talking about shifting its target from 6.5% unemployment to 6%.
The reality is, they will keep moving the goalposts. Once you slash rates to zero and start printing money, it is impossible to stop without doing huge damage to the economy. QE and zero-rates will be around for a lot longer than most investors yet realise.
When Mark Carney arrived from the Bank of Canada to his new office in Threadneedle Street this summer, he brought with him his much-trumpeted policy of ‘forward guidance’. He made it clear that rates would stay at 0.5% at least until unemployment fell to 7%. Only then would the Bank contemplate edging them back up to the 5% or so that would indicate that Britain was getting back to normal. At the time, Carney probably thought that 7% unemployment was so far in the distance that rate rises would not be on the agenda until 2017 at least – maybe even longer.
But as it turns out, Britain has had a stronger rebound than Carney or anyone else expected. Combined with its ability to create lots of low-paying jobs, this means unemployment has come down faster than forecast. The latest monthly figures showed the unemployment rate dropping to 7.6% from 7.8%: at that pace, rates would be rising before next spring.
So what does the Bank do? It has started making noises abouthow the 7% target is not set in stone. It will also be looking at other factors, such as the level of ‘real’ wages, or productivity growth rates, before tightening policy. In other words, it is shifting the goalposts to avoid being backed into a corner on when it has to raise rates.
In America a similar process is underway. When it launched QE and slashed rates in 2009, this was designed as an emergency response to the financial crash. As two years turned into three, then four, the Fed came up with a 6.5% unemployment target as a trigger for ‘tapering’ the money it is feeding into the economy each month.
Last week a paper by a pair of Fed officials discussed whether 6.5% was perhaps a little on the high side, suggesting a 6% target instead. The chances are that new Fed chair Janet Yellen will adopt that figure. And once that is close to being met? Perhaps the Fed will also look to rising real wages. Or something else entirely.
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The reality is, even if central bankers have not yet admitted it to themselves, once you slash interest rates to near-zero, it’s hard to get them back up again. And once you start QE, it’s hard to stop. You need only look at Japan. The Japanese cut rates to 0.5% in September 1995. Nearly two decades later, they still haven’t gone back up. Nor is there any sign they will. In fact, the Bank of Japan keeps throwing more stimulus at the economy.
There is little reason to suppose that America, Britain, or, indeed, the eurozone, will be any different. There is very little sign of inflation taking off – in fact, it is easing off at the moment. Asset bubbles are popping up all over the place, but there is no evidence to suggest centralbankers worry about those. Meanwhile, near-zero rates have long since stopped being an ‘emergency measure’ and have become the new normal.
As they become embedded in the economy, the rate rises that would get them back to ‘normal’ are simply too extreme. Companies have issued billions in bonds, not at 0.5%, but at 3%-4%. Mortgages have been taken out at the same levels. Governments have run up vast deficits, on which they are paying 2% interest or less.
Is it really possible to triple all those payments without creating a wave of bankruptcies, repossessions and huge public-spending cuts? Of course not. Yes, this might be tough on savers, because they will never get a decent return on their money again. And it might mean investment ends up going into all the wrong things – what economists call the ‘misallocation of capital’. But if central bankers worry about any of that, they have shown no sign so far.
In truth, the main task facing Carney and Yellen now is finding fresh excuses for shifting the goalposts again. Rates will rise once husbands no longer forget wedding anniversaries. QE will be ‘tapered’ once children go to bed on time.
Monetary policy will get back to normal when England wins the World Cup. The trick will be to find something so unlikely that there is no chance of the target ever being met – because the reality is that once rates have been at 0.5% for five years, it is near-impossible ever to get them back to normal.