The “nationalization of bond markets” left central banks unprepared for inflation, says top HSBC economist

One Canada Square, in the heart of the Canary Wharf financial district, seen between the Citibank Building and the HSBC Building on October 14, 2022 in London, United Kingdom.

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The prolonged period of loose monetary policy following the global financial crisis has amounted to a “nationalization of bond markets” by central banks and has meant policymakers have been slower to contain inflation over the past two years, the statement said HSBC Chief Economic Adviser Stephen King.

Central banks around the world have aggressively raised interest rates over the past year to curb rising inflation after a decade of easy financial conditions. The rapid rise in interest rates has fueled concerns about a possible recession and exposed weaknesses in the banking system that have led to the collapse of several US regional banks.

Speaking to CNBC on Friday at Italy’s Ambrosetti Forum, King said that while quantitative easing has benefited economies trying to recover from the 2008 financial crisis, its duration means governments are “probably doing a lot too relaxed about increasing the national debt”.

“Part of the problem with QE was the fact that you are essentially nationalizing the bond markets. Bond markets play a very, very useful role when you have inflation, which means it’s an early warning indicator,” King told CNBC’s Steve Sedwick.

“It’s a bit like an enemy bombing raid and you turn off your radar systems – you can’t see the bombers coming, so it’s basically the same thing, you nationalize the bond markets, the bond markets can’t react to initial increases in inflation, and by the time central banks recognize them, it’s too late, and that’s what I think has happened over the last two or three years.”

The US Federal Reserve has been slow to raise interest rates, initially claiming that the rise in inflation was “temporary” and the result of a post-pandemic demand surge and ongoing supply chain shortages.

“So effectively you have a situation where they should have raised rates much, much earlier than they did, and when they finally got to raising rates they didn’t really want to admit they made a mistake themselves had,” said King.

He pointed out that last month’s “jitters” in the financial system, which included the emergency bailout of Credit Suisse by Swiss rival UBS, were likely the result of an extended period of low interest rates and quantitative easing.

“What encourages you to do this is effectively raise money very cheaply and invest in all types of assets that could do very well for a short period of time,” King said.

“But when you start realizing you have an inflation problem and you start raising interest rates very, very quickly, as we’ve seen over the past few years, then a lot of these financial bets start going pretty bad wrong.”

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