How QE impacts commodities

The economic cycle of depression/recession has created the need for Quantitative Easing (QE), the occasionally used and effective tool used by central banks across the globe. The world knows all about it and will be remembered for ages. Before we delve deep in to this topic, it is essential to understand the basic definition of this much hyped “Quantitative Easing” and how it is supposed to work.

Quantitative Easing can be defined as monetary policy used by central banks to stimulate the economy when standard monetary policy has become ineffective. The new money swells the size of the bank reserves and lower interest rates will stimulate the economy by encouraging banks to make more loans which in turn boosts investment.

Most rich economy central bankers began printing money to buy assets during Great Recession and few like the Bank of Japan, are still at it. Several rounds of QE in America have increased the size of the Federal Reserve’s balance sheet, the value of the assets it holds, from less than $1 trillion in 2007 to more than $4 trillion now. The ECB is just the latest central bank to jump on board the QE bandwagon. Its monthly purchases will rise to €60 billion until at least September 2016.

The question now is: were the QE and the prolonged period of low interest rates done by the Federal Reserve effective, whether it would be effective for Japan as well as for the Euro area. The injection of additional funds in to the financial system created new problems. Some of the free and cheap money went to buy shares, bonds, commodities and currencies of fast-growing or high yielding economies. The new cash pushed up prices and supported unsustainably fast GDP growth in some developing nations. It may all have looked good for a while, with growth in the US housing and the labour markets, the two biggest sectors. But now, with the end of QE and the end of ultra low interest rates era probably sometime in 2015 by the Federal Reserve, the result is wobbly financial and commodities markets and a sudden downturn in funding for countries such as India and Indonesia, which are complacent about running large current account deficits.

On the other hand, the QE done by the ECB will probably have limited impact on the economy. The Euro-zone has already injected €1 trillion worth of liquidity in the eurozone in various ways in the form of near zero interest rates, LTRO (Long Term Refinancing Operation) etc.

Bank lending remains the key channel through which QE would filter to the real economy. Non-financial corporations get 85 per cent of their funding from banks in the eurozone, the figure in the US is less than half this. The lack of lending from the broader capital markets means money will not filter through to the real economy anywhere as effectively as in other places. This means asset (as also commodities) prices will not feed through to consumers to the same extent.

Any sovereign purchases will likely have to be split according to the ECB capital shares. This means that almost half of the capital injection will flow to Germany and France, 26 per cent and 20 per cent respectively. It is also highly unlikely that a bout of QE would stimulate demand in Germany and thereby encourage the eurozone rebalancing many hopes for. However, all that glitters is not gold. Although, the main aim of QE is to maintain prices levels, or inflation, these policies can backfire heavily, leading to high levels of inflation due to costlier commodities. In case commercial banks fail to lend excess reserves, it may lead to an unbalance in the money market.

All things equal, it remains to be seen, how QE as a monetary tool will be effectively managed by central banks. Although Japan is on it for a very long time, growth in the eurozone will be measured by how the policy measures, apart from QE is accepted and implemented by the respective government and nations in order to propel growth.

The writer is Associate Director – Commodities & Currencies, Angel Commodities Broking Pvt. Ltd. Views are personal.

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