# Governments and central banks risk inflation, Bank of England has done its bit, now the politicians’ turn
Author:  Pal Sinha, Barnali 
Author URL: https://financedigest.com/author/pal-sinha-barnali
Published: 2016-08-25
Category: FINANCE
Category URL: https://financedigest.com/category/finance
Meta Title: August 2016: Capital Markets Update
Meta Description: Get the latest on August market updates, including a rise in MSCI World index and US stock market highs. Dive into the impact of bond yields and monetary
URL: https://financedigest.com/governments-and-central-banks-risk-inflation-bank-of-england-has-done-its-bit-now-the-politicians-turnhtml

![undefined](https://prod.superblogcdn.com/site_cuid_cm5qst7v3003gwirgwqtxn8i8/images/0o1a9049-2739-1736844551933-compressed.jpg)

**Tom Elliott**, deVere Group’s International Investment Strategist

August is traditionally either a vague, directionless month for capital markets or one of shocks, their impact exaggerated by thin trading liquidity. Not this August, which has seen the MSCI World index rise 0.95% in USD terms (0.94% in local currency) over the last two weeks and the Barclays Aggregate Bond index up 0.29% in USD.

Last week saw record highs for the major American stock market indices (S&P500, DJIA, and the Nasdaq Composite), the strong July labour [data release undoubtedly helped drive the US market](https://www.financedigest.com/crowdsourcing-of-data-to-drive-the-nucleic-acid-isolation-purification-market.html "Crowdsourcing of data to drive the Nucleic Acid Isolation Purification Market"), even if the volatile record of that data this year should suggest treating it with caution. The FTSE 100 reached a 14-month high of 6,916 helped by a fall sterling that ended the week at $1.29, while Japan and continental [European stock](https://www.financedigest.com/european-stocks-rally-for-fifth-day-as-defensives-miners-climb.html "European stocks rally for fifth day as defensives, miners climb") markets are all at two month highs.

If it was [improved expectations for the US economy that helped lift American stock markets](https://www.financedigest.com/demand-for-meatless-products-and-vegetable-proteins-is-expected-to-improve-nutritional-yeast-market-sale.html "Demand For Meatless Products And Vegetable Proteins Is Expected To Improve Nutritional Yeast Market Sale"), elsewhere the fall in government bond yields has been the driving force, which in the case of UK gilts has been dramatic. The 30-year gilt offered a yield of 2.2% shortly before the E.U referendum on 23 June, it is now at 1.22% after a [Bank of England rate](https://www.financedigest.com/expert-view-bank-of-england-lifts-uk-rates-to-3-in-historic-hike.html "Expert View: Bank of England lifts UK rates to 3% in historic hike") cut 10 days ago, the announcement of more quantitative easing and the expectation of further monetary easing to come should the UK economy suffer a post-Brexit recession (which appears likely). The rally in UK gilt yields has in turn helped [put downward pressure](https://www.financedigest.com/analysis-war-in-ukraine-puts-pressure-on-east-european-banks-to-prop-up-sinking-currencies.html "Analysis-War in Ukraine puts pressure on East European banks to prop up sinking currencies") on other sovereign bond yields, which has then fed through into lower yields on corporate bonds.

As [bond yields](https://www.financedigest.com/analysis-banks-lag-bond-yield-surge-as-recession-worries-trump-cheap-valuations.html "Analysis-Banks lag bond yield surge as recession worries trump cheap valuations") fall, equity dividends become relatively more attractive. Who can’t resist the 3.65% yield on the FTSE100 index, or the 2.4% on the FTSE Global ex UK index, when [bank account cash interest rates](https://www.financedigest.com/czech-interest-rates-already-at-high-level-central-bank-governor-says.html "Czech interest rates already at high level, central bank governor says") are zero and the 10year gilt offers just 0.61% and the 10 year Bund -0.17%. The 10 year Treasury yield of 1.51% looks like high yield in comparison, reflecting as it does the possibility of a [Fed rate hike later this year](https://www.financedigest.com/u-s-dollar-rallies-to-more-than-2-year-hike-on-steep-fed-rate-hike-outlook.html "U.S. dollar rallies to more than 2-year hike on steep Fed rate hike outlook").

**Governments and central [banks risk](https://www.financedigest.com/strategies-banks-use-to-manage-liquidity-risk.html "Strategies Banks Use to Manage Liquidity Risk") inflation**

**1)** **Will stimulative [monetary policy](https://www.financedigest.com/asian-economic-powers-warn-of-risks-from-war-monetary-policy-normalisation.html "Asian economic powers warn of risks from war, monetary policy normalisation") result in inflation?**

- How long can stimulative monetary policy continue to support [global stock](https://www.financedigest.com/global-stocks-to-grind-higher-lacklustre-year-ahead-reuters-poll.html "Global stocks to grind higher, lacklustre year ahead: Reuters poll") markets? We don’t know. What we do know is that monetary policy is becoming increasingly experimental, for example with many economists urging central banks to use ‘helicopter money’ (ie, central bank-issued cash deposited directly into people’s bank accounts) in order to encourage consumption in the [euro zone](https://www.financedigest.com/euro-zone-recovery-gathers-pace-allays-fears-of-recession-pmi.html "Euro zone recovery gathers pace, allays fears of recession-PMI") and Japan.
- Meanwhile – and this is ironic given the [record lows](https://www.financedigest.com/pro-beijing-patriots-sweep-hong-kong-election-with-record-low-turnout.html "Pro-Beijing ‘patriots’ sweep Hong Kong election with record low turnout") seen on gilt yields last week – it is clear that the new UK government is not only less keen on fiscal austerity than its predecessor, but may be about to engage in some classic Keynesian infrastructure spending in order to help support the economy as it goes through the uncertainties of Brexit. Populist politicians throughout the euro-zone are challenging the austerity ‘imposed’ by Germany as they see to run [budget deficits in excess of the agreed 3% of GDP](https://www.financedigest.com/austria-plans-to-bring-budget-deficit-within-3-of-gdp-next-year.html "Austria plans to bring budget deficit within 3% of GDP next year") limit.
- Could looser monetary and [fiscal policy all end](https://www.financedigest.com/hp-to-cut-about-12-jobs-by-end-of-fiscal-2025.html "HP to cut about 12% jobs by end of fiscal 2025") in inflation tears?

**2)** **What stops inflation from taking off today?**

- Factors that inhibit inflation currently taking off include: 1) a large build-up of sovereign and private sector debt (essentially bringing forward future consumption), 2) poor demographics in many developed economies (an aging population spends less), and 3) over-sized [current account](https://www.financedigest.com/coffee-current-accounts-and-the-commoditisation-conundrum.html "Coffee, current accounts and the commoditisation conundrum") surpluses in Germany, China and other Asian countries (which amounts to the hoarding of money). But history is awash with examples of governments that experimented with monetary expansion in order to [boost demand](https://www.financedigest.com/how-are-rising-cyber-threats-boosting-demand-for-public-safety-software.html "How are Rising Cyber Threats Boosting Demand for Public Safety Software") and resist deflationary pressure, only to find that they had printed too much money and/or that policy interest rates had -in retrospect- been too low, for too long.

**3)** **What can investors do?**

- As ever, investors can find some shelter from this uncertainty through a fully diversified portfolio. This should include ‘real’ assets such as property, commodities etc that have a [track record](https://www.financedigest.com/britain-on-track-for-record-black-friday-sales.html "Britain on track for record Black Friday sales") of offering protection against inflation, as well as equities and bonds.
- Gold (currently at $1,336) has been flat month-to-date, but is interesting for several reasons. First, as a protection from inflation. Second, with global bond and equity dividend yields trending downwards the [opportunity costs](https://www.financedigest.com/modified-flour-market-overview-cost-structure-analysis-growth-opportunities-and-forecast-to-2032.html "Modified Flour Market Overview, Cost Structure Analysis, Growth Opportunities And Forecast To 2032") of holding gold has steadily reduced. Indeed, as more and more government bonds offer a negative yield to maturity, gold benefits because it offers [investors at least the possibility of receiving back](https://www.financedigest.com/exclusive-new-investor-backs-bt-says-fibre-jv-may-not-be-needed-source.html "Exclusive-New investor backs BT, says fibre JV may not be needed – source") the sum invested.

**[Bank of England](https://www.financedigest.com/bank-of-england-publishes-rules-for-energy-firms-liquidity-tool.html "Bank of England publishes rules for energy firms’ liquidity tool") has done its bit, now the politicians’ turn**

- The Bank of England [fired heavy artillery](https://www.financedigest.com/north-korea-fires-artillery-into-sea-as-south-korea-and-u-s-pledge-cooperation.html "North Korea fires artillery into sea as South Korea and U.S. pledge cooperation") at the UK economy on 3rd August, announcing a broad range of monetary policy measures designed to protect the economy from the negative impact of the 23rd June Brexit vote. It is now up to the UK government to [assure investors](https://www.financedigest.com/apollo-assures-investors-deposit-flight-wont-spill-over-to-athene.html "Apollo assures investors deposit flight won’t spill over to Athene") that government policy will be pro-growth, and to articulate a Brexit policy that will cause as little disruption as possible to the economy.
- The central bank downgraded Q3 GDP growth to just 0.1% q/q, from a surprisingly strong Q2 figure of 0.6% q/q, while [forecasting a stagnant economy for the six size of the  period](https://www.financedigest.com/piston-rings-aftermarket-to-witness-cagr-of-4-increase-in-value-share-during-the-forecast-period-2019-2029.html "Piston Rings Aftermarket to Witness CAGR of 4% Increase in Value Share During the Forecast Period 2019 – 2029") October to March 2017. Its [forecast for the economy by end](https://www.financedigest.com/britains-kingfisher-sees-annual-profit-towards-higher-end-of-forecasts.html "Britain’s Kingfisher sees annual profit towards higher end of forecasts") of 2019 is now 2.9% smaller than it had been in May. Governor Mark Carney warned that unemployment will rise, house [prices will fall](https://www.financedigest.com/factbox-european-gas-prices-why-have-they-been-falling.html "Factbox-European gas prices: why have they been falling?"), and inflation rise. But, he added, the economy is resilient enough to bounce back from the Brexit shock.
- Some warning of the [scale of the measures had been given by the Bank’s](https://www.financedigest.com/scams-have-eroded-digital-trust-banks-need-to-do-more-to-combat-the-industrial-scale-of-scams-in-the-uk.html "Scams have eroded Digital Trust – Banks need to do more to combat the industrial scale of scams in the UK.") chief economist Andy Haladane, who said in July that he would ‘rather run the risk of taking a sledgehammer to crack a nut than a miniature rock hammer to tunnel out of prison’. The measures included a much-anticipated 25bp [interest rate](https://www.financedigest.com/london-stocks-slip-ahead-of-key-interest-rate-decisions.html "London stocks slip ahead of key interest rate decisions") cut, taking the Bank’s key policy rate down to 0.25%. A new ‘Term Funding Scheme’ was announced, by which £100 m will be [made available](https://www.financedigest.com/lyme-disease-treatment-market-forecast-to-2031-made-available-by-top-research-firm.html "Lyme Disease Treatment Market Forecast to 2031 Made Available by Top Research Firm") to banks to make new lending. This is designed to ensure the impact of the rate cut is felt by as many people in the economy as possible.
- Finally, we have a new £70 bn quantitative easing programme that will include around £10 bn of corporate bonds. The announcement of a second QE programme, available for sometime in the future in the event of it being needed, had been anticipated. But no-one expected the delivery of such a programme this month. An initial purchase by the Bank of England of long-dated bonds last week failed to attract the £1.17bn it had aimed for, reflecting the dilemma of the [insurance companies](https://www.financedigest.com/allianz-trade-wins-global-banking-finance-reviews-best-trade-credit-insurance-company-asia-pacific-2022.html "Allianz Trade wins Global Banking & Finance Review’s Best Trade Credit Insurance Company Asia Pacific 2022") and pension funds who tend to own long dated debt, and who will struggle to find alternative liability-matching assets to buy.
- We look for a [clear statement on what the UK government means by Brexit](https://www.financedigest.com/post-brexit-insurance-reform-clear-before-december-says-boes-woods.html "Post-Brexit insurance reform clear before December, says BoE’s Woods"), and how its vision will be achieved with minimal economic disruption to the economy, over the coming months. The Bank of England is doing its part in supporting the economy, it is now down to the politicians to do theirs.


---
This blog is powered by Superblog. Visit https://superblog.ai to know more.
---