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El-Erian Comments on Today’s Central Bank Action

“Mohamed El-Erian, chief executive and co-chief investment officer at PIMCO, submits this guest post to FT Alphaville in reaction to this morning’s coordinated announcement.

Risk markets love liquidity injections, real and perceived. As such, they will welcome today’s announcement by six major central banks to reduce the price of emergency financing and broadening its scope. They will also like the possibility that this dramatic coordinated move provides a stronger context for further actions at the level of individual institutions.

In justifying the move, the central banks point to the need to counter pressure on “the supply of credit to households and businesses and so help foster economic activity.” This is an objective that will sell well to the public and politicians. But it is not one that will be effectively met by the announced measures. Indeed, the importance of the announcement is elsewhere, involving two related issues.

First, these monetary institutions feel that, again, they have to move because other entities have continued to be too slow and too ineffective; and second, they feel that they cannot, and should not ignore an actual or anticipated need to relieve acute pressures within the banking system.

These two reasons were made even more pressing by last week’s dislocations in the functioning of European financial markets – most notably, the inversion of the Italian yield curve, pressure on government bond markets in core Europe, the growing fragility of the banking system, a drop in market liquidity, and growing hesitation by market participants to warehouse any risk.

The immediate impact on markets unambiguously favors risk assets across the world. The longer-term effect depends on the scale and scope of the follow through from others. This is particularly important as we count down to yet another European Summit on December 9.

The hope is that central banks are acting because, looking forward, they feel confident that other policymakers will finally catch up with a big and spreading debt crisis that has serious implications for growth, jobs and inequality. The fear is that they are acting because they feel that they must again pre-empt yet another set of potential disappointments.”

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