11 August 2016

A difficult choice

While the cut in interest rates by the Bank of England was well signalled in advance, the implications for markets remains clouded.


Of course, it wasn’t the only measure introduced by the Old Lady of Threadneedle Street. Monetary easing is to be stepped up by more quantitative easing and through the introduction of a new scheme aimed at encouraging banks to up their lending to business. Governor Mark Carney seems determined to head off a Brexit induced recession.

Whether he will be successful is open to question. For a start, the latest bout of QE involved the Bank buying long dated gilts at above market prices – except insufficient sellers were tempted out to fulfil the order. This is surprising, but perhaps indicates that QE itself could be running out of steam. More evidence that this could be the case might lead the new government to adopt different tactics, perhaps replacing monetary easing with some form of fiscal stimulus.

QE is a huge financial experiment, introduced by central banks to counter the recessionary pressures brought about by the global financial crisis of 2008. It involves these important financial institutions expanding their balance sheets massively – printing money, in effect. Such measures might reasonably encourage inflation, but cost of living increases have been muted to say the least. In Japan it is government policy to up the inflation rate, but success there has been limited.

Nobody really knows what the consequences of ending this great experiment will be. Indebtedness, arguably a core reason for the crisis itself, has if anything increased since printing money became a central policy tool. In the US they are already reining in monetary easing, but only slowly, citing Britain’s decision to leave the European Union as one reason for caution. It will need some better signs that the globa l economic recovery is on a firm footing to encourage central banks to tighten, in my view.

For investors the choices are difficult against a background so beset with uncertainties. The S&P 500 Index in the US stands at an all-time high and looks expensive on both historic and relative criteria. Here at home markets have recovered well since the referendum and have reached new high ground for the year – not too far short of last year’s record for the FTSE 100 Share Index. But we still have the consequences of the Leave vote to sort out, while it is a Presidential election year in the US, with all the uncertainty that creates.

The alternatives do not look too appealing either. Yields on government securities are at all-time lows and getting a decent return on cash is well nigh impossible. Even the residential housing market seems to have gone off the boil. For the time being patience and following a diversification strategy seems the prudent course. This could turn out to be an interesting year for investors.

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