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February 4, 2010 2:29 pm
Overabundant credit got the world into this mess. For a while, it got us out. But the liquidity is being turned off. The Bank of England has paused its quantitative easing programme. As for the European Central Bank, it first signalled an exit from “credit-easing” last year. Really, that is all investors need to know. Last year rising liquidity lifted all markets. This year the ebb tide is returning them to earth.
In the UK it was the central bank itself that bought government bonds, almost £200bn in all. In the eurozone the agent of QE has been commercial banks. In the first half of 2009 their bond purchases funded the region’s budget deficits – including those of Greece and Spain. Tapping ECB liquidity at 1 per cent and lending to governments at, say, 4 per cent was a profitable trade, as Deutsche Bank’s results suggested on Thursday.
But bad debts are increasing – Santander on Thursday boosted its bad debt provisions by €2.6bn. At the same time sovereign risk is rising as the flow of abundant money into bond markets halts. Europe’s banks therefore face a double peril. No wonder their shares have sold off this week.
Meanwhile central banks have more traditional agendas increasingly on their mind. First is the uptick in inflation, not just of Giacometti sculptures but consumer prices too. Second, especially in Europe, is the need to enforce fiscal propriety on governments – or, via a withdrawal of liquidity, for bond markets to do the job.
In Europe this has produced Greek tragedy and, if pursued, perhaps a Spanish one too; in the UK, so far only a comedy of manners. Just as British politicians, both in government and in opposition, pedal back from promises to cut spending, the Bank of England is moving in the other direction. Still, the Bank’s message about the economy was downbeat. QE has not made its final stage exit yet.
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The Bank of England voted to hold interest rates at record lows and said it would not extend its quantitative easing programme, under which it has purchased just over £200bn, mostly in government gilts.
Also on Thursday, the European Central Bank left official interest rates unchanged for a ninth consecutive months. The eurozone is struggling to recover growth and is reeling from financial market worries over public finances across much of the region, which have sent the bond yields of peripheral European governments higher.
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