QE2 is not an old luxury cruise liner, but a reference to more quantitative easing from central banks, especially in the US, the UK Europe and Japan.
The Fed is heading that way, the Bank of Japan is there as is the Bank of England and the ECB won’t be far behind
The AMP’s chief economist, Dr Shane Oliver says this is good news for Asian currencies, gold and the $A, especially with the RBA about to raise interest rates, most likely at the October meeting.
Another round of global monetary reflation is likely getting underway with the US Federal Reserve and the Bank of England indicating that they are now considering additional monetary easing and Japan undertaking its own easing in moving to push the value of the Yen lower.
This has major implications for foreign exchange markets, the gold price and the next asset price bubble.
The key driver is the sub-par nature of the recoveries in the US, Japan and Europe and the inability of fiscal policy to respond further given already high public debt levels.
With interest rates at or close to zero, central banks look to be turning to another round of quantitative easing.
Technically this involves expanding the size of the central bank’s balance sheet and basically involves using printed money to buy securities, so as to increase the quantity of money in the system.
Increase the supply of something and its price normally falls!
Following its September meeting the US Federal Reserve has indicated that it is considering more monetary easing if needed to support the economic recovery and push inflation back up to levels more consistent with price stability.
And since the Fed Funds rate is close to zero this effectively would mean another round of quantitative easing (or QE2), which would involve using printed money to buy Treasury bonds.
With US growth now below the level necessary to stop unemployment from rising (which is at least 2.5% pa) and the Fed likely to revise down its 2011 growth forecasts, it’s likely to engage in quantitative easing following its November meeting.
Market speculation is that the Fed is considering undertaking another $US1 trillion of asset purchases (which is the equivalent of 7% of US GDP). Coming on the back of $US1.3 trillion in Fed asset purchases in 2008-09 this would result in a further sharp rise in the size of the Fed’s balance sheet (see the chart below) and another big increase in the supply of US dollars.
Market expectations of QE2 in the US and a resultant increase in the supply of US dollars have seen renewed downwards pressure on the $US.
The Bank of England has also indicated that it is considering more quantitative easing.
Tiring of seeing the Yen move ever higher in response to a weakening $US, Japan has responded by starting to buy US dollars and by leaving the increased supply of Yen in the economy in what is called unsterilized intervention.
As such it has essentially engaged in quantitative easing itself.
Currently it has only spent Yen2 trillion but purportedly has Yen35 trillion available, which would be about 7% of its GDP and hence roughly match the potential US easing.
? So far Europe has merely complained about the Bank of Japan’s intervention and it is still reaping the benefits of the weaker euro seen over the December to May period.
But with the euro rising sharply again in response to a weaker $US and fiscal tightening likely to impact next year there is a good chance that it will also be forced into quantitative easing next year.
The end result is likely to be an increase in the supply of US dollars, Yen, British pounds and euros and a race down in each of these currencies, with the $US leading the charge.
Such “beggar thy neighbour” policies or “competitive depreciations” will no doubt result in worries about all sorts of things, in particular inflation and trade tensions.
Inflation is a risk but as with QE1 it isn’t going to happen until people start spending and spare capacity, evident in circa 10% unemployment in the US and Europe and idle factories, is used up.
Right now the bigger risk is deflation, so G3 central banks can afford to take risks with printing more money.
Another obvious issue is: will it work?
Quantitative easing operates by injecting more cash into banks, lowering mortgage rates and corporate borrowing rates (as government bond yields fall) and pushing the exchange rate lower (at least against countries not doing the same). But so far US banks have not leant much of the cash out from the first round of quantitative easing (i.e. the money multiplier remains low) and mortgage rates are already at record lows.
The counter of course is that QE1 probably did prevent a worse outcome, banks will be able to further rebuild their balance sheets, further falls in mortgage rates will allow more US homeowners to refinance their loans at lower rates and the $US will at least fall against non-major currencies providing a further boost to its exports.
And Fed Chairman Ben Bernanke feels that he at least has to try!
So what will it all mean?
There are several implications from another round of monetary easing.
First, it means another boost to global liquidity which should at least support growth, if not provide an additional boost to growth going forward.
Second, it will likely be positive for share markets and other listed growth assets as it was through last
