13th April 2016 at 1:06pm
In my last article I mentioned that policy decisions by central banks look key to stimulating economic activity.
Following on from the European Central Bank’s (ECB’s) surprise announcement about measures to help boost the flagging Eurozone economy, the central banks of the UK, the US and Japan had important decisions to make on which way they’d go: take further action, or batten down the hatches?
The ECB’s actions: too little, too late?
The aim of the ECB’s changes was to try to stop the eurozone from slumping into deflation.
At Standard Life Investments, we see the ECB’s actions as fairly positive for economic growth in the eurozone – both in terms of design and scope.
The focus on supporting domestic demand through further quantitative easing is particularly positive. However, whether this is enough in the face of global and local headwinds remains to be seen.
Bank of England keeps the UK on an even keel
All members of the Bank of England’s Monetary Policy Committee (MPC) voted unanimously to keep the bank rate at 0.5% and to maintain quantitative easing levels at £375bn.
Despite 12-month inflation rising to 0.3% in February, it’s still well below the target rate of 2%. There are a number of reasons why this could be the case: unusually low energy and food prices, weaker sterling after a period of strength, weak global inflation and few increases in the cost of everyday items.
The MPC has decided to be cautious with monetary policy to make sure that economic growth returns to target in around two years – as long as no further financial shocks rock the boat.
The US holds its course
The US Federal Bank (the Fed) also decided not to change interest rates. Instead it has decided to monitor inflation and financial markets closely before making any further changes.
The Fed hopes that keeping policy unchanged will support improvements in the labour market. Similar to other countries, it has pointed to global economic and financial developments as reasons why the US economy is only strengthening at a moderate pace.
It did state that rates were likely to remain at a low level for some time to come as any moves to its inflation objective would be gradual.
All in all then, no change is consistent with Standard Life Investments’ expectations for two rate hikes this year, as long as there are no further financial shocks.
Japan: hope versus reality
Then there’s the Bank of Japan. Economic data from Japan shows little sign of a recovery since the central bank made the surprising decision to move to negative interest rates earlier this year.
This means it charges commercial banks 0.1% for holding cash reserves in a bid to encourage businesses and savers to spend and invest.
But the hope that this would boost the recovery seems to have fallen flat, with continued sluggish economic behaviour, particularly in the areas of exports and production.
Because of this, we see scope for more quantitative easing to turn around the recently stronger yen, although a move to cut interest rates further remains uncertain because of the adverse effects it could have on the banking sector.
As I’ve discussed before, turbulent market activity in China can often cause short-term ripples around the globe. The Bank of England’s first quarterly bulletin of 2016 looked at the longer-term implications of a shock to growth in China on the UK.
It found that a 1% drop in Chinese gross domestic product (GDP) would be likely to lower UK GDP by 0.1% because of a combination of trade, financial and confidence factors, as well as lower oil prices.
It also pointed out that the impact wouldn’t only be a result of direct links between the UK and China. It would be because of stronger ties between China and the UK’s traditional trading partners, such as the US and the euro area.
All around the world
It’s now seven years since the worst of the global financial crisis came to an end. But the world still seems plagued by economic problems: too little growth, not enough inflation, too much debt, ineffective monetary policy and fragmented politics – to name the most important ones.
But not everything is heading in the wrong direction. A range of inter-related forces have contributed to a narrowing of the difference between exports and imports in many countries – which is a positive thing.
A country has what’s called an ‘external imbalance’ when the money it brings in from exports is more than the money it spends on imports, and vice versa.
The end of the commodity boom has reduced current account balances in many of the large commodity-producing countries and improved balances in a number of countries which import commodities.
Large currency depreciations have also had an impact in a number of emerging market countries. And the eurozone crisis put an end to the large current account deficits in the four European Union states with the weakest economies, including Portugal and Spain. So some of the imbalances potentially threatening the current economic cycle have been curtailed, rather than increased.
What does this all mean when you’re investing?
It’s important to remember that financial markets are constantly moving and changing, and various factors could potentially lead to more or less financial turbulence during the rest of 2016.
We still believe it’s important to be selective when deciding where to invest. Different types of investments and regions are affected by different factors. What’s positive for one type of investment or region can be negative for another, or may have no impact at all.
That’s why we encourage taking a diversified approach to investing. And in a world of slow growth, Standard Life Investments sees yield and income from equities, corporate bonds and property as an attractive investment theme.
The information in this blog or any response to comments should not be regarded as financial advice. Past performance is not a guarantee of future return. Please remember that the value of your investment can go up or down, and may be worth less than you paid in.