Unravelling quantitative easing

Financial markets don’t like surprises, so the long-awaited start of the unwinding of the US quantitative easing (QE) programme confirmed last week has been signalled since the beginning of the year. If the policy can be successfully reversed without triggering unwanted side-effects like the 2013 “taper tantrum” – when investors panic-sold bonds and caused a fall in global markets – then similar changes can be expected in the UK and Europe. 

The scale of QE programmes is mind-boggling – QE has led to a quadrupling of the value of assets on the US government balance sheet to $4.2tr (£3.09tr), equivalent to $13,000 (£9,600) per person. Meanwhile, the European Central Bank continues to purchase €60bn (£53bn) of assets per month, while the UK’s QE programme remains capped at £435bn. 

Even though no new money is being pumped into US or UK bond markets, the impact of recycled investment continues to keep demand for gilts at elevated levels, suppressing interest rates and encouraging other investors to seek better returns from more risky assets such as corporate bonds and infrastructure investments.

Many construction clients have been major beneficiaries of QE, but I suspect the wider industry is less aware of how the system has worked in practice, sustaining demand and price levels. QE does involve “printing money”, although the effects are communicated through financial markets rather than through direct spending programmes. By using new money created by central banks to buy new and existing government bonds, QE increases levels of demand for gilts and as a by-product helps to push down long-term interest rates. 

Pension funds and other long-term investors have focused much more of their money into capital-intensive sectors such as infrastructure and property

Outside of the bond purchase loop, investors benefit from lower interest rates but must look for riskier investments than government bonds to secure an acceptable return. Because of QE, pension funds and other long-term investors have focused much more of their money into capital-intensive sectors such as infrastructure and property, while small-scale investors such as buy-to-let landlords have benefited from low interest rates and a sparkling housing market. 

In practice, the major beneficiaries of QE have been asset owners, including pension funds, house-owners and infrastructure businesses. The less well-off have been expected to rely on a “trickle-down” resulting from a little more investment and a little more spending. Construction has been a major beneficiary of this effect – with strong order books and high levels of inflation.

So, what could the impacts of a change in QE policy be? Lessons learned from the global market crash in 2013 mean that unwinding must be slow – taking perhaps a decade or more to shift some of the holdings of government debt onto corporate balance sheets. At the same time, the “end of austerity” would require increased public-sector borrowing – increasing the supply of new debt to markets just as demands for investment spending on infrastructure and the retooling of modern economies ramps up. 

If all goes well, GDP growth will continue to accelerate, interest rates will start to rise in response to inflationary pressures and the level of demand for investment in new assets will be sustained. But if there is a blip, then the balance between the supply of assets and demand for them could change, reversing an eight-year bull market. 

This all sounds very long term and hypothetical. However, the impacts of QE since 2009 have been anything but. Accordingly, how could the unwinding of QE impact on construction markets and future levels of demand? The answer is quite a lot. Low finance costs and rising asset values are closely interlinked – not only in property markets, but also in infrastructure where costs of borrowing have become an increasingly sensitive element of project viability. Thames Tideway and the recent successful offshore wind auction have both benefited from low funding costs that reflect in part the need for investors to accept higher levels of risk to secure a reasonable income. Similarly, higher interest rates would reduce affordability in the housing market.

Whatever form the next generation of government intervention takes, it will be delivered without the QE cushion

Rising asset values have insulated construction markets from many negative impacts of austerity seen in the public sector. Access to QE-supported markets has been a saving grace for construction since 2009, not only because it has increased levels of demand, but also because rising asset prices have helped clients to absorb higher levels of input cost inflation in construction than other sectors.  In effect, QE has allowed construction to continue its low productivity path because asset-owning clients have been insulated by rising asset prices.

Domestic politics requires that any stimulus that takes the place of QE is aimed at the many, rather than the few. The lifting of salary caps, for example, will be a positive move for millions of public sector workers, but inevitably will have a wider impact on tax and spending decisions. Such choices will also influence future investment priorities for the public sector, which would become a more important source of funding and finance. 

Without the safety valve of rising asset values, it will be less easy for construction firms to deliver value to their clients. Whatever form the next generation of government intervention takes – whether it is focused on replacement infrastructure like the US, or targeted at solving the housing crisis – it will be delivered without the QE cushion. Weaning construction away from this support so that it can most cost-effectively deliver future investment programmes will be the primary legacy of the unravelling of current policy.