The G5 economies will again struggle to reach potential so growth is more likely to come from the swirl of cheap cash looking for a home as central banks tolerate nothing less than inflation.This sounds like 2009, when growth assets (equities, commodities, property) were carried on a tide of liquidity only until central banks turned it off. This time, central banks will have to overshoot, to make sure inflation expectations are preserved. For most, the alternative – deflation expectations – is unthinkable.
But don’t expect bond yields to surge
First, recovery is likely to remain only a two-speed process, with the ‘dollar bloc’ (US, Canada, Australia) outperforming Europe and Japan. In the G7, only the US, Germany, Canada and China have managed to surpass their pre-crisis real GDP. Australia and Sweden have too. The US rise since (up 2.2% year-on-year in 2012) has been the G7’s fastest (ex China), crimped only by government, but with the eurozone and UK still 2% to 3% lower than before the crisis, they look halfway to their own lost decade.
Second, with the tool box empty, central banks will keep QE running. Super-imposing US treasury yields on Japan’s government bond yields lagged 15 years suggests sustained QE in other countries will likewise keep their bond yields down. On the basis of our lacklustre labour market outlook, US QE will stretch through most of 2013 to avoid any policy re-tightening from the fiscal side.
In the UK, our estimates suggest another £400bn QE if new governor Carney wanted to return policy to the extreme looseness of 2009 and 2011. This would leave the BoE holding 70% of conventional gilts outstanding, though, in practice, it is likely to be in tandem with other measures. This could weaken a pound already losing its safe-haven lustre. No major country has loosened its overall policy mix more than the UK, so the pound could be a more potent channel to inflation than QE itself.
Third, the eurozone is not out of the woods. Encouragingly, Italy and Spain’s painful austerity is beginning to pay dividends. Yet, the strains will increasingly impact the core members footing the bill, and full convergence may take a decade.
Known unknowns
And, fourth, this backdrop is not helped by a slower China. New leaders Xi and Li are taking the helm, but with “doubling GDP per capita by 2020“ as the main goal, measures will be taken to build on the soft landing. The portents look encouraging, but the productivity loss will harden reluctance to strengthen the renminbi versus the dollar. This will keep the currency as a bargaining chip and, helpfully to the US, keep China as a major sponsor of treasuries.
Then there’s uncertainty from personnel changes. Elections are due in Italy (the re-run from February), Japan (Upper House, July), Australia and Germany (September 14 and 22). In the eurozone, unsynchronised and often interrupted electoral cycles mean politicians promising reform today may not be around to implement it.
New central bank governors start in Japan, maybe China, Canada, and the UK (July). In the UK, Carney will need to avoid an obfuscation of the BoE’s commitment to low inflation if yields are to stay down and the UK avoid further ratings downgrades.
But the UK is not alone in this. With low growth, most governments unready to repair fiscally, and central banks encouraging inflation, little wonder only two of the G7 (Germany and Canada) still have a full set of triple A ratings. More G7 downgrades will follow.
