Bank of England deputy governor for financial stability John Gieve has said that developments in the US sub-prime market had pointed out vulnerabilities in new credit derivative markets and the difficulty of valuing instruments on the basis of only a few years experience.
In a speech at the Barbican Centre Gieve discussed the range of uncertainty facing monetary policy makers, emerging lessons from the US sub prime market and the significance of influential investors, including Sovereign Wealth Funds.
Gieve argued that the ‘Great Stability’ seemed to have reached its zenith of total predictability between summer 2004 and summer 2006, 24 months when interest rates scarcely moved at all. Even in that period “there was a vigorous debate underway (within the MPC) about the state of the economy and the policy response” reflecting “genuine and unavoidable uncertainty about the economy which was disguised by the stability of rates but never went away”.
He described the current position as “a return to normality after two years of exceptional predictability in monetary policy both in the UK and elsewhere”.
Gieve also argued that developments in the US sub-prime market had pointed out vulnerabilities in new credit derivative markets, including a potential misalignment of incentives along the distribution chain, the changing way that exposures impact balance sheets, market liquidity drying up in stressed conditions and the difficulty of valuing instruments on the basis of only a few years experience.
He noted that the growth of Sovereign Wealth Funds over time would “tend to increase the price of riskier assets, like equities and corporate and emerging market bonds, compared to government bonds. The impact will be greater if there are concentrations of investment in particular asset classes or countries. More widely, the switch of reserve rich countries from lenders to owners of financial or real assets is also likely to lead to political tensions and pressures for protectionism”.