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Jean-Yves Gilg

Editor, Solicitors Journal

Looking for a spark

Looking for a spark


Volatility across asset classes looks likely to continue as global economies employ contrasting policies and recover at varying rates, says Claire Bennison

Western economies have become accustomed to a world of near zero interest rates following years of central bank attempts to stimulate growth.

Base interest rates in the US have been at 0.25 per cent since 2008, 0.5 per cent in the UK since early 2009, and in Europe, they are now at 0.05 per cent.

The European Central Bank (ECB) has gone a step further by reducing its deposit rate (the rate at which it pays banks for storing money with them) to minus 0.2 percent, effectively charging the bank to keep money with the ECB.

The move is aimed at encouraging banks to use their cash to generate a better return (by lending to households and businesses for instance) in the hope that it benefits the broader economy and reduces borrowing costs.

The direction of the ECB can, to a certain extent, be seen as a sign of desperation. Traditional monetary measures have not been able to meet the goals of the central bank, therefore other avenues have been explored.

When Mario Draghi pledged to 'do whatever it takes' to save the euro, he committed to adopting a range of traditional and non-traditional tools to boost growth and employment. When he exhausted those measures, the introduction of policies such as negative deposit rates and quantitative easing was only going to be a matter of time.

As alluded to earlier, one of the reasons central banks have been able to adopt these avant garde measures has been that inflation, and inflation expectations, remain very low. Eurozone inflation was negative in February, while inflation is expected to be (as measured by the ECB's survey of professional forecasters) 0.8 per cent one year from now; the lowest expected reading since the survey began in 1999.

Falls in the prices of natural resources have been timely, while meaningful wage growth is yet to materialise as economies struggle to get back to full capacity.

Currency movements

This has enabled central banks to target growth without fear of stoking inflation and has also helped with a very useful (but often underplayed) effect of lower interest rates and monetary expansion, devaluing the local currency. Foreign exchange rates are affected by a number of factors but interest rates (and interest rate expectations) continue to be the overriding driver of currency movements.

As rates and returns have fallen on safe haven eurozone assets, cash has left the euro area and moved to places like the US, where interest rate hikes are currently forecast sooner rather than later.

The euro has fallen more than 20 per cent over the past 12 months versus the dollar, as investors forecast the divergence of monetary policy in the respective regions to continue. US corporations are beginning to feel the effect of a stronger dollar on international earnings (revenue in the foreign currency translates into less dollars to be reported as earnings) and the speed at which the dollar has risen has given investors reason for concern.

Efforts to devalue the currency and help exporters become more competitive have not been consigned to Europe however. Since the turn of the year, there have been over 20 interest rate cuts globally and in February, the Swedish Riksbank became the first to cut its main policy interest rate into negative territory.

'Competitive easing' has stoked fears of a return of international currency wars, while the chair of the US Federal Reserve, Janet Yellen, has previously warned that low deposit rates could disrupt the financial system.

In this environment banks have two choices. They can either pass on negative deposit rates to customers which may lead to a flight of capital, or take the hit on these charges themselves and run the risk of eroding earnings.

With regards to the UK, the consensus has been for interest rates to rise steadily as the economy recovers, however recent comments from the Bank of England's chief economist are interesting.

Andrew Haldane suggested that policy makers may be forced to cut interest rates in the coming months to tackle deflation, a view which challenges governor Mark Carney who said cutting rates at this time would be foolish.

As policies diverge globally and policy makers look to protect their own economies, markets are likely to continue to see heightened volatility across a range of asset classes. 

Claire Bennison is regional director at Brooks Macdonald in Manchester

She writes a regular in-practice article on asset management for Private Client Adviser