The Bank of England said investors remain concerned about the euro-area outlook even after measures by policy makers helped reduced some tensions in markets.
“Concerns about the indebtedness and competitiveness of some euro-area countries persisted and remained a key influence on financial markets,” Chief Economist Spencer Dale wrote in the bank’s Quarterly Bulletin, published in London today. Still, in the three months to March 9, “financial-market sentiment improved considerably over this period amid a range of actions by policy makers, both in the U.K and abroad.”
Italian Prime Minister Mario Monti said over the weekend that Spain’s struggle with its finances could revive contagion in Europe as finance ministers prepare a deal to strengthen the region’s firewall. The Bank of England noted in the bulletin that sovereign bond yields in some countries remain “elevated.”
It also said that the European Central Bank’s three-year loans, or Long-Term Refinancing Operation, helped ease bank funding pressures.
Market contacts “thought that increased issuance in public markets combined with the ECB’S LTRO had relieved much of the funding pressure facing European banks in 2012,” the quarterly bulletin said. “But European banks continued to face elevated funding costs,” with senior unsecured U.K. funding costs exceeding levels that prevailed in the first half of 2011.
Demand for investments “perceived to be more liquid or carrying less credit risk” helped to keep gilt yields low, the Bank of England said. There was “little market reaction” to the decision by Moody’s Investors Service to change the outlook on the U.K.’s Aaa credit rating to negative from stable.
The Bank of England also said that the stop-out spread and cover ratio on its three- and six-month money market operations fell in the quarter to some of the lowest to date as rates in other markets declined and central banks’ actions boosted liquidity in the banking system.
In a separate article, the Bank of England said rebalancing the economy may have “important” implications for monetary policy as it could impact inflationary pressures.
“If demand switches from consumption to investment and exports simultaneously, leaving aggregate demand unchanged, the impact on inflationary pressure may be limited,” said Stuart Berry, Matthew Corder and Richard Williams of the central bank’s monetary analysis division. “But if the slowdown in consumption comes through more quickly than the boost to exports and investment, that is likely to lead to weaker inflationary pressure and the need for looser monetary policy than might otherwise be the case.”
Redeploying resources may also cause some friction, according to the article. That may affect monetary policy by temporarily hurting the productive capacity of the economy, thus lowering the level of demand “consistent with meeting the inflation target,” according to the article.
The bulletin also contained a chapter from a conference the central bank hosted on so-called quantitative easing in November. The Bank of England said while the presentations “broadly supported” the emerging consensus that QE and other unconventional policies helped to mitigate the impact of the financial crisis, there was “less agreement” on the magnitude of the effects. It also said there was no agreement on whether there was “scope to use these policies in normal times.”
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