In this week's IDB, we take a look at recent monetary policy developments and conclude that it is very much a case of policy Deja Vu. We also consider why economic conditions will require interest rates to remain low for some time to come.
- Despite the unprecedented policy response from Central Banks, in recent years the prevailing trend has been of revisions lower in economic growth and inflation forecasts, particularly in the developed world. Slowing world trade growth has been one of the principle drags on activity.
- The combination of lower growth and inflation expectations has given Central Banks little choice but to step on the quantitative easing accelerator. Balance sheet expansion has included not only government and corporate bond purchases, but in some cases Equities as well. Even in the US where policy has started to normalise, future interest expectations have been lowered and the Fed has taken an increasingly cautious approach. Economic conditions in the UK and Europe will similarly require the policy to remain accommodative.
- The Bank of Japan, (BoJ) recently amended its policy mix to include yield curve control. The BoJ will now target a yield of around 0% in 10 year government bonds and maintain asset purchases to achieve this objective; interest rates will remain negative. In order to raise inflation expectations, the BoJ has now committed to overshooting its 2% inflation target.
- Central Banks have no alternative but to stay the course and keep interest rates low. Aggressive monetary policy has not delivered robust economic growth, but it does help to contain the risk of recession. We therefore maintain our defensive asset allocation, with higher cash allocations and lower equity risk.
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