All hail the new age of central banking

The Bank of England has just agreed to buy another £50bn of gilts and will soon own almost a third of all government debt.

Short rates here are at 0.5 per cent. Until 2009, they were never lower than 2 per cent in the Bank’s 300-year history. The Federal Reserve has indicated that it will keep rates near zero until 2014. Again, these are record low levels for record-long periods of time.

The message to savers is very clear. Central banks do not want you to hold cash. If they can, they will keep real rates negative so that savers are eroding the buying power of their capital. In part, this is because they would like savers to shift into riskier assets.

Of course, this is because they want borrowing to be as cheap as possible, both to ease the burden of past debts and to encourage companies to invest more and create jobs.

This policy is starting to become controversial. Recently Charles Schwab, the head of the eponymous stockbroker, called in the Wall Street Journal for the Fed to stop forcing down rates and let them find their own level.

He made a point that has appeared in this column: such low rates are a sign of the central bank’s lack of confidence in the economic outlook. But Mr Schwab added that this was a negative signal to business.

Meanwhile Bill Gross, Pimco’s bond guru, has argued that, by driving bond yields down, the Fed is discouraging investors from investing at longer maturities. With Treasury bond yields so low, the rewards are limited, but the risks of capital loss – in the case of a surge in inflation – are great.

But what would happen if the Fed, or the Bank of England, raised rates? Borrowing costs would rise for all debtors, increasing the risk of default.

It would mean a tightening in monetary policy at the same time as fiscal policy was being tightened – more so in the UK than the US. There is the chance that both economies would be pushed back into recession.

And low interest rates are not the only way in which central banks are supporting the economy.

The recent stockmarket rally has been driven, in part, by the actions of the European Central Bank, which has lent heavily to banks at three-year maturities. This programme has reduced the threat of a banking collapse and has helped lower yields in Italy and Spain.

In Britain, the Bank of England is buying a further £50bn of gilts, bringing its pile up to £325bn, approaching a third of all issuance. The Fed is also trying to hold down long-term yields on Treasury bonds. And, by extension, these lower bond yields are designed to prop up the equity market as well.