Quantitative easing measures to end in 2016

December 24, 2015 15:47
Even after the US Federal Reserve's interest rate hike, the global market will still have ample liquidity. Photo: Bloomberg

While the US Federal Reserve's interest rate hike is within market expectation, in terms of scale and timing, the policy decisions by the European and Japanese central banks are somewhat surprising, given their worse than expected economic and inflation data.

It is correct to say the global market will still have ample liquidity even after the Fed rate hike as other major economies like the European Union, Japan, the United Kingdom and China are maintaining their loose monetary policy.

But it doesn’t mean there’s still room for the quantitative easing (QE) policies to expand. I will make a bold forecast: 2016 will be the year of QE's end.

In the Fed statement, chairwoman Janet Yellen said if things turned worse, further rate rises would be suspended. Some analysts, in fact, said it is possible for the US to cut rates again next year.

We cannot rule out even a 0.1 percent chance that that could happen.

A key question, however, is whether the interest rate rise was brought about by an improving US economy. I think there are two factors behind the Fed decision: one, a stronger economy, and two, the Fed wants to protect its credibility to pave the way for the second phase of interest rate normalization.

The low interest rate environment has lasted for seven years; the expansion of QE is not unlimited.

Ample liquidity will boost the debt levels of both the government and the private sector. Government debt now accounts for 103 percent of the US GDP. Combined with that of the private sector, the ratio is 370 percent.

Theoretically, if total debt is 250 percent of the GDP or over, long-term economic growth will decelerate at least 25 percent. In other words, further QE expansion will drag down growth.

Investors also show weaker confidence in central banks’ QE measures. In the past seven years, money flowed into financial assets instead of using it to expand business which would be more risky. Low capital cost has led to worse capital allocation.

As the US enters the second phase of interest rate normalization, Japanese and European central banks become more cautious to avoid triggering another round of financial tsunami.

Next year should mark the end of QE. Governments can take more fiscal or administrative measures to boost the economy.

This article appeared in the Hong Kong Economic Journal on Dec. 24.

Translation by Myssie You

[Chinese version中文版]

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head of private banking and trust services at Hang Seng Bank