Investment Desk Bulletin

06 October 2017

Removing the Punchbowl

Removing the Punchbowl

By Sanjay Joshi

As Central Banks look to remove the punchbowl, we take a look at the potential impact on financial markets.

Since the financial crisis Central Banks have deployed an unprecedented monetary policy mix of ultralow interest rates and quantitative easing. Nine years on, given the progress made in strengthening the banking sector and restoring the global economy to synchronised growth, central bankers are making tentative steps towards removing emergency measures.

In the US, the Federal Reserve started the process of gradually raising interest rates in December 2015, and from next month they will start reducing the size of its balance sheet. Well managed policy guidance and a firm economic backdrop should limit any adverse investor reaction.

In the UK, the Bank of England has signalled a policy shift in response to rising prices, and future interest rate expectations have now reverted to pre-Brexit levels. However, consumer driven UK growth looks increasing threatened by rising levels of household debt, low real wage increases and Brexit uncertainty. Consequently, the Bank of England will need to remain cautious.

The European economy is expanding at a healthy pace, with sentiment indicators pointing towards 2% economic growth this year. Although the European Central Bank may be considering monetary policy normalisation, they are unlikely to move quickly because inflation remains below target and the Eurozone remains in the early stages of its recovery.

The shifting monetary policy regime poses risks, especially given the success Central Banks have had in supressing financial market volatility. If inflation remains contained and wage pressures subdued, there is a risk of increasing interest rates prematurely.