From RBS comes the first of no doubt many 2016 prediction lists. This is one spot on in my view:
1. There are limits to monetary policy. Central bankers will be tested in 2016. The economic equilibrium based on monetary stimulus, but lack of other measures is circular and fragile. Central bank balance sheets cannot grow indefinitely and forward guidance cannot target asset prices, without damaging credibility. Investors are growing increasingly wary of central bankers’ credibility, and worried about the effectiveness of further stimulus (ECB, BoJ) and their ability to reverse policy (Fed, BoE).
2. Fiscal stimulus, reforms and investment remain scarce. The result is more QE in Europe and Japan, and a very shallow reversal of policy in the US and UK. We expect the ECB to deploy more QE in December, extending the length of the programme and the list of eligible assets. We think the BoJ will continue expanding its balance sheet as well. Conversely, exiting QE will be difficult even in the regions where it is deemed most successful – the US and UK – given lack of balance sheet deleveraging, or re-leveraging. Our economists expect the Fed to start hiking in December and to end at 1.5% at the end of 2016, with risks skewed to the dovish side, and the Bank of England to start hiking in August 2016. We think the impact of ECB QE2 will be temporary, as for QE1, due to persistent structural issues in the Eurozone economy. Despite convergence in periphery-core financial spreads, investment and loan volumes continue to decline, according to ECB data. The opportunity for US and European governments to build on the recovery is infrastructure investment and reforms, respectively. But what we are seeing is still too little, too late.
