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How much more QE? Markets need their sugar high

Markets have got very used to the leading Central Banks creating plenty of new money to buy up bonds. This has boosted both bond and share prices. Recently there are early signs that the Central Banks might like to reduce the amount of support they provide. Investors need to keep an eye on this.

QE written on cube with dollars background

Charles Stanley

in Features;


Last week the Bank of Canada slipped out that it was cutting its Quantitative easing programme by one quarter, taking it down to C$3bn a week of bond buying from C$4bn. They got away with it, and markets remained unruffled. Over at the ECB, Mrs Lagarde wanted people to know they are accelerating their QE programme of bond-buying,  despite the lower figures recently. She assured her audience that they had experienced very high redemptions, where bonds they owned were repaid by governments. This means they needed to buy even more to  replace the redeemed ones at the same time as expanding the stock. She too got away with her explanation without clarifying why they did not cover all the redemptions anyway. The markets decided the ECB will do what it takes and will keep rates very low for a long time.

At the end of March, the Bank of Japan also tampered with the way it buys bonds and what it tells us. It has widened the permitted margin over its pledge to keep the 10-year interest rate at zero percent,  by permitting itself a market induced variation of 50 bp in the interest rate. It also announced it will in future be more precise about how much it intends to buy. The markets have challenged the Fed to reassure them they are going to keep rates down, and have recently accepted the words the Fed has used.  Most market participants work on the assumption that QE will contribute on a big scale, and assume that is needed to sustain bond prices and keep share markets moving ahead.

Meanwhile, the piles of bonds continue to accumulate in the ledgers of the Central Banks. Japan has bought the most in relation to the size of the economy and now has holdings approaching the level of Japanese GDP. The ECB, Fed and Bank of England have also added significantly to their holdings to combat the pandemic pressures.

Does any of this matter? The Japanese model implies that a state can get away with printing enormous quantities of money to buy up huge quantities of state debt. This allows the state to expand its spending or reduce its tax revenues and borrow the rest at zero interest rates without penalty. The Japanese position does have three characteristics that do not all apply to the other big three Central Banks. Japan runs a balance of payments surplus so it does not need to borrow from overseas.  It has an ageing population with a strong savings habit. It has no inflation. The Eurozone is nearest to Japan in having a balance of payments surplus, an ageing population and quite low inflation. The UK and USA are more prone to inflation, run large balance of payments deficits and have younger and expanding populations. This is likely to limit their scope to expand QE indefinitely and to cause their Central Banks to taper or pause the policy earlier.

Markets may come back to test these banks again if investors worry that on the sly the Central Banks are reining back their bond buying too much. Markets have grown to like the strong support offered to bonds on tiny yields for many months, and to like the way that washes much more money into share markets as people sell their bonds to the Central Banks. So far the Central Banks have taken modest steps away from huge support and do not look ready yet to inflict too much pain on markets.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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