BAML: This is the real reason central banks have implemented QE

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Around the world, government bond yields are continuing to trend lower, up until recently seemingly hitting fresh record lows each and every day.

This is no better demonstrated than in the chart from Bank of America-Merrill Lynch (BAML), shown below. It shows benchmark 10-year sovereign bond yields for advanced economies in the US, Europe and Japan.

Part of the reason is subdued expectations for growth and inflation in the period ahead, seeing investors favour capital preservation rather than yield should the global economy go belly up.

Alongside that factor, and perhaps an even greater driving force behind the move lower in yields, has been the actions of central banks. Quantitative easing (QE), as it is known, has also played a part.

BAML’s US economics team explains:

QE programs are really misnamed: the central banks’ goal is not to increase the money supply in the hope that banks will lend more. And banks don’t base their lending decisions on how many reserves they have. Rather, both are looking at interest rates: banks look at the expected rate of return on a loan relative to holding other yield-bearing assets, and make lending decisions based on that comparison.

Central banks buy assets in order to bring down yields more generally to entice borrowers — and to make it less enticing for banks and other lenders to just tie up funds in safe, low-yielding assets, instead of lending to help expand private activity.

All the action is on the interest-rate side, and central banks arguably have been successful in bringing down longer-term bond yields and, thus, borrowing costs.

It’s hard to disagree that QE has been successful in helping to lower interest rates, hence borrowing costs to the public and private sectors. While subject to debate, many believe that is also helping to underpin global growth at a time of economic fragility by loosening financial conditions.

However, while lower rates have helped to reduce loan servicing costs for existing borrowers, questions remain over their ability to encourage borrowing for investment outside the financial sector, particularly given the signal ultra low rates are sending on the outlook for the economy.

Lowering rates is one thing. Getting firms and households to borrow is another.

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