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Monday, December 6, 2021

Geopolitics will bring this long bull market to a close, not interest rates

Enjoy it while it lasts, for one thing that can be said for sure is that something will eventually come along that will rock the complacency of investors to the core, even if it’s impossible to say what it might be until it actually happens.

The big “known, unknown” is inflation and interest rates, a threat which is neatly summarised by Neil Shearing, chief economist at Capital Economics, in the following terms.

“Asset markets may take a modest increase in interest rates in their stride, particularly if it comes against the backdrop of a strong macroeconomy. But if markets start to believe that central banks have fallen behind the inflation curve, and that a larger response is required, a bigger shake out in markets would surely follow.”

As it is, the major central banks seem stubbornly resistant to the pressure to raise interest rates, knowing that any undue tightening risks crashing not just the casino of stock markets, but the real economy to boot.

Bets against the pound have reached their highest level in more than a year on the assumption that the Bank of England will soon be forced to abandon its somewhat curious strategy of warning of higher inflation and rate rises to come while coincidentally doing nothing about it.

The danger in this approach is that when the Bank does eventually act, it will be forced to hit the brakes in a much more heavy handed way than otherwise, bringing the economic recovery to a grinding halt. The policy challenge is similar at both the US Federal Reserve and the European Central Bank.

Perhaps it was unavoidable, but the default policy of countering any piece of bad news with another bout of quantitative easing has landed the world’s leading monetary authorities in a terrible mess; they are on a treadmill from which there appears to be no escape.

In a speech to the Institute of International Monetary Research this week, Lord King, former Governor of the Bank of England, said that further central bank money printing had become “unsustainable”. Yet “the challenge of reducing the size of those balance sheets at a time of large budget deficits is self-evident”.

Indeed so. Rarely have the public finances looked quite as reliant on the easy money of central bank support, as they do today.

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