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Proceeding with caution on QE

Patience is a virtue, they say. After years of discussions but little in the way of progress, the pandemic has spurred the cash-strapped G7 to finally agree a firm tax plan for the super wealthy tech giants. Now they will pay tax where they make their revenues, rather than in the low tax haven of their choice.

It’s an important step, not only for disgruntled nations who have felt cheated, but also for tax fairness, for all non multinationals who are unable, or choose not to get away with such tax liberties. However, we shouldn’t get carried away. It’s not the end of the battle. Lots of details have yet to be thrashed out, while the eventual deal might mean the UK’s share of the tech windfall is not the “huge prize for taxpayers” promised by Rishi Sunak, and there are already signs that the deal could be as disappointing for the UK as it is for its tax-haven neighbour Ireland.

Still, this rosy prospect of big tech paying up and a strong economic recovery as countries emerge fully from lockdown leads to one question: at what point will central banks pull down the shutters on their emergency monetary response to the pandemic crisis?

Quantitative easing (QE) was unleashed in the UK and the US well over a decade ago, followed by the European Central Bank a few years later. It has saved economies and markets from recessions and crashes. Yet this “extraordinary” measure has never really been reeled back in. Although the Fed did shrink its balance sheet after the financial crisis, the Bank of England continued to replace maturing bonds. Then Brexit came along. UK interest rates have remained in a range of 0.1 to 0.75 (and that high was only for a brief period) per cent for a decade. Compare that with the 10 years leading up to the financial crisis when “normal” rates fell into a range of 5 to 7.5 per cent.

No doctor wants to see their patient topple over when they pull away the crutch – and high government borrowing is another incentive to keep rates low – but the danger for central banks is that QE overuse will weaken its potency during the next crisis. We’ve been here before, after the financial crisis. And lessons were learnt. The main one being that it’s much better not to scare the markets into thinking that they are going to be cut loose from all support, or to act too soon.

So, despite all the discussion around inflation risks and key material shortages the ultra calm message from the central bankers is that they are relaxed about inflation, and rising prices are only temporary. If persistant inflation comes, they will respond but only after the event, not before, and with the gentlest of nudges.

QE is a system that boosts equities and house prices, and keeps borrowing costs ultra low, but it mostly benefits those who already have wealth. It’s no good for savers, and although low rates are great for borrowers, including the government, they mean low margins for lenders. A sharp phasing out would hit confidence but, even so, a naturally functioning market will yield many benefits. And having been through it before, markets are better prepared, and less likely to throw tantrums. 

However, bar an unexpected announcement to the contrary at the G7 Cornwall summit this weekend, it seems likely that QE will be with us for at least another year or two, and the most we should expect is some passive shrinking of balance sheets.