Are central banks directly financing governments or just pumping up asset prices?

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by Shaun Richards

This morning has seen policy announcements from two of the world’s main central banks. First from Japan which has taken policy further than anyone else and then from the world’s oldest central bank the Riksbank of Sweden. However there was a claim yesterday in The National that the UK and the Bank of England in particular has taken things even further than the Bank of Japan.

When it came to the pandemic, the Bank of England side-stepped QE and started buying government bonds (debt) directly. This has provided the money needed to support the UK economy during the pandemic.

This is from a comment piece by Jim Osborne of the Scottish Banking and Finance Group and it continued in the same vein.

While the Bank of England has been directly financing the UK Government, it has also provided loan guarantees to the private banks to encourage them to lend to businesses and support them through the prolonged lockdown of the economy.

A sort of doubling down on the direct financing front. and then we have something which even the most extreme central bankers may balk at.

The Bank of England has always been able to provide direct finance to the Government – it is the primary function of a central bank.

The first bit is true it can but if something is a primary function you might expect it to be used whereas in fact it has not done so since the early part of 2009. You may remember the media furore over the potential re-activation of the Ways and Means account in April of last year. The media have been much quieter about the fact that the amount there has remained at a nominal £370 million and in fact has been that since the spring/summer of 2009. It was used when the credit crunch hit for a few months and rose to just under £20 billion but has not been used since.

As for Bank of England QE purchases of which there will be another £1.48 billion this afternoon these are not direct financing either.It follows a rule that it does not buy a bond for a Beatles week ( 8 days for non Beatles fans). So it is smoothing the road but it is not directly financing the government as claimed.

Bank of Japan

This morning brought a case of steady as she goes from the Bank of Japan.

The Bank will purchase a necessary amount of Japanese government bonds (JGBs) without setting an upper limit so that 10-year JGB yields will remain at around zero percent.

This does give some food for thought on the issue of what is the primary function of a central bank now? The inflation targeting theme has been in choppy waters in Japan for several decades.

Bank of Japan Gov. Haruhiko Kuroda will fail to reach his goal of stable 2% price growth during his term, after what will have been more than a decade of stimulus to stoke inflation, according to the bank’s latest forecasts.

Even with an economy expected to show a faster recovery from the COVID-19 pandemic, a slew of rising commodity costs and global expectations for accelerating inflation, the BOJ still couldn’t find enough positive factors to see price growth averaging 2% by the end of March 2024. ( Bloomberg)

I am trying to think of anyone or anything which has been more of a serial failure than the Bank of Japan on this front. Remember that Governor Kuroda was supposed to be the equivalent of a central banking storm trooper and he had indeed performed that role as highlighted below.

The Bank will purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) as necessary with upper limits of about 12 trillion yen and about 180
billion yen, respectively, on annual paces of increase in their amounts outstanding.

For newer readers the ETF purchases are how the Bank of Japan buys equities. This is how it acquired the moniker of The Tokyo Whale as its holdings have now passed 36 trillion Yen. Whilst we get a perpetual stream of presumably leaked articles in the media that it will buy less the reality is always of more. That has been highlighted this month because it bought another 70 billion Yen on the 21st when the market had the temerity to fall towards 28.500 in terms of the Nikkei 225 index.

So in fact if we were looking at a primary function for the Bank of Japan you could make a strong case for it being pumping up asset prices. Its enormous Japanese Government Bond purchase programme pumped them up and in the Abenomics era it was driven the Nikkei 225 from around 8,000 to 29,000. Rather curious because neither are in its inflation measure. Actually they seem finally to be driving house prices higher again because December (2020) saw 1.6% monthly growth meaning annual growth was a bit under 4%.

Meanwhile as we have already noted there is no consumer inflation to speak of. This is signaled by this morning’s measures of underlying inflation release which shows it at depending which measure you choose either 0% or 0.1%.

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Riksbank of Sweden

We see a familiar pattern highlighted by this from @LiveSquawk earlier.

Riksbank’s Ingves: Economic Picture Has Brightened Monetary Policy Needs To Remain Very Expansive

Or if we put it more formally they expect this and the emphasis is mine.

The differences between various sectors and groups on the labour market are expected to remain high, but overall economic activity is expected to approach more normal levels towards the end of the year.

So if you take the view that policy changes require 18/24 months then you take your foot off the accelerator?

Expansionary monetary policy in the years ahead is needed to support the economy and inflation. The Riksbank is therefore continuing to purchase assets within the envelope of SEK 700 billion and to offer liquidity within all the programmes launched. The Executive Board has also decided to hold the repo rate at zero per cent and it is expected to remain at this level in the years to come.

So that’s a no as there is still quite a bit of QE to come.

Through the asset purchase programme, the Riksbank’s holdings of securities had until 23 April 2021 increased by SEK 453.5 billion.

Comment

We see several things today. The initial point made by The National of the Bank of England directly financing the UK government is not true. But there is a point to day that the primary function of central banks is to pump out asset prices or if you prefer to create asset price inflation. So far the Bank of Japan is alone in driving equity prices higher as well but the list of central banks driving bond prices higher and thus gifting their respective government’s lower debt costs gets ever longer. These days they also do the same for larger corporates.

The problem with this is two fold. By now we see that QE has not created the consumer inflation promised although of course there is a big issue here about how it is being measured! Also as we noted yesterday looking at commodity prices some is on its way.But more fundamentally even before the pandemic economic growth was struggling in many places even before the present virus pandemic. This poses a problem because we have just seen a lot more of what looks like in the medium to long-term to restrict economic growth. Also younger readers will no doubt be mulling the way that assets are increasingly being priced beyond their reach as a matter of official policy.

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