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Stagnation in the UK’s broad money supply presents a clear danger to risky assets – and suggests there is a growing chance the Bank of England will expand its asset purchase facility, says Jamie Dannhauser at Lombard Street Research.
He acknowledges that the £200bn ($319bn) of quantitative easing so far has almost certainly prevented a sharp drop in the stock of broad money and left private sector liquidity conditions far better than they otherwise would have been – although not yet consistent with a sustained recovery in the economy.
But recent signs of broad money contraction, largely due to forced balance sheet restructuring by banks to bolster capital and cut dependence on short-term wholesale funding, has left risky assets heavily exposed to a shift in risk appetite.
“The widespread belief that record low interest rates have left financial markets awash with liquidity over the past year is patently false,” he says.
“Since March, risk assets have benefited from a weakening desire to hold cash. Low interest rates have helped, but the key driver has been a sharp drop in risk premia as fear of financial Armageddon has ebbed away.
“But ultimately, a sustained bull market in risk assets is very unlikely without consistent growth in broad money and that condition is not being met due to bank deleveraging.
“The Bank of England could well feel a further monetary injection is needed this month.”