If the emergency’s over, central banks will find it ever harder to justify any further extensions of emergency monetary policy.
Investors were given a little taster of this when, after the European Central Bank’s second long-term liquidity operation, equity and precious-metals markets fell back. Oh sure, the markets are bouncing back. It’s hard to keep the bulls down. But central bankers have started their hinting campaign that the endless supply of free money has a time limit.
Ironically, the ECB’s LTRO could yet prove the high-water mark for global liquidity. ECB President Mario Draghi has been enormously generous to euro-zone banks by providing them more than €1 trillion in three-year money at, as far as we can tell, a 1% interest rate.
He made it clear that he wanted banks to take as much of this cash as they could to prevent a potentially fatal credit crunch. Many banks have now resolved their financing requirements for the next couple of years. Though most are having to reduce leverage, which means less impact of the LTRO money on boosting economies than would otherwise be the case, at the margins they will be able to support peripheral sovereign debt. Which is why Italian and Spanish debt has rallied so strongly.
But Mr. Draghi has also made clear that, having been given this enormous cash windfall, banks now need to sort themselves out. For one thing, it is unlikely the Bundesbank would tolerate further liquidity schemes like this one.
And, as U.K. banks showed following a similar, albeit smaller-scale liquidity scheme launched by the Bank of England early in the crisis, it won’t be long before the recipients of LTRO money have to think about how to replace this welfare funding from the markets.
Soon after the ECB’s operation, Federal Reserve chairman Ben Bernanke began his semi-annual Congressional testimony.
Although he remained cautious about the state of the U.S. economy, the lack of hints of further policy actions suggested to investors that QE3 is off the table.
Indeed, with U.S. unemployment starting to fall fast, the Fed may well have to reconsider the likely interest rate path over the next couple of years. Enormous bank reserves represent a huge challenge for central banks. If inflation comes, it won’t come in single figures but as legions of big numbers.
To complete the central banking hat trick, members of the Bank of England’s policy-setting committee also offered their own testimony to parliament. The takeaway there was that yet more quantitative easing is very unlikely, especially as BOE members start to worry that oil prices will cause yet further inflationary overshoots during the coming year or two.
The era of easy money isn’t over by a long chalk. But the era of ever-easier money probably is. And the withdrawal of stimulus could be coming sooner than people think.