US holds key to proving sceptics wrong on quantitative easing

Is QE medicinal or poisonous?

This month our focus has again been on quantitative easing (QE) programmes and whether they actually provide benefits to economies. In just a few weeks we have seen the US Federal Reserve stop its QE programme, the European Central Bank (ECB) showing that it is reluctant to make any decisions over its QE programme and Japan opting to expand its own.

So which strategy is right?

Of these moves the one by the Bank of Japan (BoJ) was the most unexpected. The BoJ expanded its QE programme by ¥20 trillion (Dh644.2 billion), which means that it will now be injecting ¥80tn per year. We had for some time been saying that the BoJ was underestimating the negative effect of its rise in sales tax, but we did not expect QE to be expanded.

The bank’s action could be considered an admission of a partial failure, as the economy is losing momentum. It is true that QE has succeeded in generating some inflation, however it is still not certain that it will hit its target of 2 per cent “reflation” by next April.

Growth has shown a notable decline this year, which raises speculation that Japan is heading back into recession. The issue that the country is facing is that it has almost no options left – all it can do is increase its bond buying and devalue its currency.

The announcement led to a significant drop in the yen. The dollar/yen spiked above 115.50 and remains stabilised around this price. The Nikkei 225 also spiked by more than 10 per cent in only a few days. But many people are now asking how long the BoJ will be able to continue with this policy. Its QE programme has been there since 2000.

The economy remains far from where it is intended to be, but if QE is stopped the most likely outcome will be that the economy will slide back into recession. This is an ever-increasing worry as the BoJ’s large balance sheet makes ending QE in Japan almost impossible.

The expansion of QE has led to a massive rally in asset prices, which can now be seen as a bubble. Ending QE would be extremely risky and almost certainly lead to bond yields soaring to a record level. But who will buy all those trillions of bonds, what would the yield be and, most importantly, at what price will the bonds be sold? These questions are hard to answer for the time being, but what we now know is that the government may think twice about raising the sales tax again next year. It may even revise the current policy very soon, especially if economic activity continues to deteriorate further.

So what is the future for QE? Everyone is watching the US after the Fed ended its programme, and by the second quarter next year we will have found out whether this strategy has worked. The ECB has been reluctant to act so, for the time being, QE in Europe will remain at the same level. QE has a positive impact on the short term, but the long-term effects can be extremely damaging. We have never been convinced that QE leads to a healthy economic recovery, but we hope that the US will prove us wrong.

Nour Al Hammoury is the chief market strategist at ADS Securities

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