The world’s rate-setters are on manoeuvres. After a decade of unorthodox monetary policy involving rock-bottom policy rates, quantitative easing and, in the case of Japan, intervention in the stock market; central banks are looking to roll back these measures and begin shrinking their balance sheets. As a result of the measures employed to ward off another Great Depression, the role of central banks and the impact of their actions has come under increased scrutiny, prompting a renewed focus by their leaders on the importance of maintaining central bank independence, free from political interference.
In the US, gradually increasing interest rates and tighter global monetary conditions have been the principal cause of the pull back in the equity market we have witnessed in the past few weeks, with the S&P 500 down -8.8% and the MSCI ACWI Global Equity Index falling -7.8% for the month to date (both in local currency terms). This deceleration of market momentum does not chime with the desired narrative of the current resident of 1600 Pennsylvania Avenue, resulting in direct criticism of Chairman Powell by the President in an interview with the Wall Street Journal. This led to Powell needing to build support in Congress to defend the independence of the central bank.
In Europe, at the meeting of the ECB last Thursday, Mario Draghi expressed his confidence in the Eurozone’s “broad-based economic expansion” and committed to ending QE at the end of this year, while keeping rates at historic lows until next year. Draghi also felt the need to emphasise the importance of central bank independence calling it a “precious thing, essential for the credibility of central banks”. Draghi also acknowledged the risks of waning economic momentum, protectionism and Brexit, but the Euro was broadly stable following the conclusion of the meeting.
The UK is an excellent example of why central bank independence matters to investors and economic stability more generally. Before the Bank of England was made independent following the Labour election victory in 1997, the setting of interest rates was highly politicised and elections influenced the timing and magnitude of rate changes. Removing this was hugely important for maintaining the credibility of the BoE with the markets, and over the period since independence inflation has been relatively low and stable. Economic outcomes like those witnessed by Turkey and Argentina are excellent examples of what happens when market participants stop believing that the central bank will do what it says it is going to do. With this in mind, when one recalls the Shadow Chancellor, John McDonnell, and his desire for a “people’s QE” it becomes apparent that threats to the independence of central banks reside neither in the past, nor on the far side of the Atlantic.
