Central Banks No Longer Cushion Economies and Markets

If governments, companies and markets needed any further reminders that their operating environment is changing, they got it last week. Despite weakening economic momentum and volatile financial markets, a second systemically important central bank, the European Central Bank, reiterated its intention to stop using large liquidity injections to support economic activity and asset prices. The change in this “global factor” is translating into a volatility “regime change” in markets, requires an evolution in investment strategies, and calls for compensating pro-growth policy measures on the part of many individual countries.

The ECB’s Oct. 25 announcement that its governing council still intends to stop large-scale asset purchases, known as quantitative easing or QE, at the end of the year occurred in the context of what central bankers acknowledge is an increasing list of threats to their economies. At a news conference after the central bank’s policy meeting, ECB President Mario Draghi said the risks include an uncertain trade regime, pressures in emerging markets, politics, and the budgetary confrontation between Italy and the European Union. And by stating that the “ECB mandate does not involve financing government’s deficit,” Draghi emphasized the implicit message that neither governments nor markets can continue to rely on regular, large and predictable liquidity injections to offset their own problems.