Monetary stimulus supports markets despite Cyprus crisis

CAPITAL COMMENT

THIS week, the financial markets have been given a sharp reminder that all is not well in the Eurozone. When it comes to policymakers trying to save the single currency, almost anything now seems possible. But if we’ve learnt any lesson from the past few years, it is that politicians have a tendency to be unpredictable – the Cyprus debacle is a case in point. How EU leaders can think it acceptable to impose an almost indiscriminate tax on depositors is beyond the comprehension of many.

The initial reaction from markets was understandable, with a sell off in the euro and across equities. But interestingly, there have been signs of support for risk assets. And we’ve seen similar support after comparable bouts of uncertainty, namely over the US fiscal cliff and the Italian elections. So far the FTSE has bounced well off the lows formed on Monday, as the initial fears seem to have dissipated. And the main reason for this is because equity markets continue to remain well-supported by the prospect of further central bank stimulus.

Take the Federal Reserve, for example. Its current quantitative easing program dwarfs anything that the world’s largest economy has done before, with plans to continue throwing $85bn (£56.2bn) a month at the problem for probably another two years. This isn’t an intravenous drip of stimulus – this is a full blown stimulus overdose from which is going to be incredibly hard to go cold turkey.

The European Central Bank, has barely touched the sides, in comparison, so if the Eurozone crisis does escalate we can expect more from its president “Super Mario” Draghi. He has, after all, said that he’ll do anything to save the euro. For the Bank of England, outgoing governor Sir Mervyn King is attempting to spark up a few fireworks of his own before Canadian Mark Carney takes his place in the summer. Markets are expectant of new unconventional monetary stimulus measures in the UK. Certainly the chancellor is hoping for that to happen, as we’ll likely see in today’s Budget that the British economy is unfortunately still in the doldrums.

And we mustn’t forget the Bank of Japan. Where do you start with that central bank? Many would have thought that, with so much quantitative easing from the Bank of Japan in the past, it would be bored of monetary stimulus. But recent developments suggest that this is far from the truth, as it aims to achieve its 2 per cent inflation target.

With expectations of further stimulus around the world, risk assets could remain an attractive play for investors. This means there’s the potential that we could see more record highs from stock indices in the months and years ahead. But as we all know, what goes up must come down and this asset price inflation is potentially creating the next big bubble to burst. And this bursting is likely to come when central banks force their economies to go cold turkey.

Angus Campbell is head of market analysis at Capital Spreads. You can follow him on Twitter @AngusCapSpreads

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