When all else fails, try to do more. For years, central banks have struggled to stimulate the economy and induce inflation through QE. QE programs have focused on bond purchases (although they can include other assets). So, one obvious result has been an increase across the developed economies in central-bank holdings of government bonds, measured as a percentage of total outstanding debt. In Japan, there may well not be enough bonds left that the private sector is willing to sell – meaning that, to continue QE, the BOJ could have to buy equities (having dipped into exchange-traded funds last year) or anything else it can get its hands on.
Another way to influence the economy is via the depreciation of the exchange rate. To induce those movements, the ECB and the BOJ have experimented with pushing interest rates into negative territory. Alas, as has become increasingly clear in recent months, this is no magic solution, especially in relatively large economies such as the Eurozone and Japan. Eurozone banks have largely failed to apply those negative rates to deposits, implying that the negative rates imposed by the ECB narrow margins in the banking sector. The ECB’s new targeted longer-term refinancing operations appear partly designed to offset the drag on bank profits. Effectively, this amounts to paying banks when they increase lending.
In Europe as in Japan, the scope for further rate cuts looks increasingly limited. Instead, there may be further changes to ECB’s QE mix. Already, the ECB has announced it will buy non-financial corporate debt as part of its QE program. This supports our broadly positive view on all fixed-income products in the Eurozone that have some credit risk – from periphery sovereigns and investment-grade corporate bonds to better rated high-yield bonds, which should benefit from spill-over effects. Investors should be aware, however, that the scope for policy errors is growing. The longer-term implications of QE remain uncertain – for details, have a look at our CIO View Special: “The limits of monetary policy: Are central banks losing their magic touch?”
Central banks, such as the Bank of England (BoE), already hold a large share of outstanding government debt. The problem for the BOJ in particular is that it is becoming increasingly hard to find willing sellers.