Bloomberg/London

ECB president Jean-Claude Trichet has said his bank will withdraw some liquidity operations

The world’s biggest central banks are starting to unwind emergency measures introduced earlier this year to stave off a second Great Depression.
The euro rose after European Central Bank President Jean-Claude Trichet said on Thurs his bank will withdraw some liquidity operations, and the pound climbed after the Bank of England slowed the pace of bond purchases. A day earlier, the Federal Reserve outlined the circumstances in which it would be prepared to raise interest rates.
The moves suggest that investors and executives will soon have to do without the flood of liquidity that propped up the economy earlier this year, as concerns about new asset bubbles start to mount. The danger is that mistiming the withdrawal of support could spark swings in currencies and spoil a recovery before it has taken root.
“There are all kinds of risks,” said Jim O’Neill, chief global economist at Goldman Sachs Group Inc in London. “We don’t know how much of the improvement in markets is due to central banks’ largesse, and neither do they. They’re pretty nervous, but they’ve got to get out of it at some stage.”
The Bank of Japan decided on October 30 to end its programmes of purchasing corporate debt in December. The Fed, the ECB and the Bank of England kept their benchmark interest rates at record lows. The Fed left its rate close to zero, the ECB held at 1% and the Bank of England remained at 0.5%.
The euro rose as much as 0.3% against the dollar on Thursday and the pound jumped as much as 0.8%.
Central banks are shifting course as factories restock inventories and the prices of assets from stocks to sugar and gold surge. The MSCI All-Countries World Index has jumped 66% since March and sugar has gained 90% this year.
“Not all our liquidity measures will be needed to the same extent as in the past,” Trichet said, signaling the ECB won’t renew auctions of 12-month funds next year. The Fed reiterated it will complete housing debt purchases by April.
Bank of England chief economist Spencer Dale said on September 24 he’s concerned about “unwarranted increases” in asset prices. The central bank said yesterday it will expand bond purchases by £25bn ($41bn) to £200bn, the smallest increase since it started buying bonds in March.
With traders able to borrow at record-low interest rates in the US and Europe, some economists are concerned that markets are becoming distorted, raising the potential for volatility as central banks reverse emergency policies at different speeds.
“As soon as the first exit measures are put in place, there’s the risk that the market overreacts,” said Juergen Michels, chief European economist at Citigroup Inc in London. “We’ll probably see a tightening of financing conditions, and hard-fought-for improvements will be in jeopardy.”
The Reserve Bank of Australia, which this week became the first central bank to raise interest rates twice this year, said today the nation’s economy will expand at more than three times the pace forecast in August and signaled it will continue to raise borrowing costs.
Nouriel Roubini, the economist who forecast the financial crisis in 2006, said on Wednesday that investors are milking the “mother of all carry trades.”
While policy makers in the US and Europe are pulling back unorthodox policies, rate increases may be some way off.
The Fed said on Wednesday that it may keep borrowing costs “exceptionally low” for an “extended period.” Trichet said on Thursday that ECB rates are “appropriate,” signaling he has no immediate plan to increase them, and the UK central bank said there will be a “slow recovery.”
Bank of Japan Governor Masaaki Shirakawa and his colleagues on October 30 stressed they have no plan to tighten policy.
“Bubbles, frothy stock markets and booming property prices are not a problem in the US, UK or continental Europe at the moment,” said Barry Eichengreen, a former senior policy adviser at the International Monetary Fund who now teaches at the University of California at Berkeley. “They are a problem for China and other emerging markets. It’s their central banks that need to tighten, not ours.”
For now, mounting evidence of a global recovery may encourage policy makers in the Group of Seven nations to keep withdrawing stimulus into next year. Cisco Systems Inc chief executive officer John Chambers said on Wednesday he sees a global economic recovery, “with the US leading the way,” fueling a rebound in his company’s sales this quarter.