With virtually every other central bank in the world taking a softer line in 2019 it is no great surprise to see our very own Bank of England doing the same.

A 20 June Monetary Policy Committee vote of nine to zero to leave policy unchanged is perfectly in keeping with the concerns that the Bank of England continues to express about the economic implications of Brexit but also wider concerns over global growth and inflation (and why we are not seeing enough of either).

Australia, New Zealand, Chile, India and Russia have all cut interest rates this year, the European Central Bank is considering further monetary stimulus and the US Federal Reserve is laying the groundwork for its first interest rate cut since December 2008.

The chances of the Bank of England looking to join Norway and the Czech Republic among those who have increased interest rates in 2019 look pretty slim, especially as any unexpected tightening of policy could give sterling a boost and perhaps hamper exports at what remains a delicate time for the UK economy.

Investors must now address two issues. First, why are central banks readying themselves to play fast and loose with monetary policy once more? Second, what are the implications for portfolios?

Money makes the world go round

What appears to concern central banks more than anything else is their inability to stoke inflation (unlike the 1970s, when they made very heavy weather of slowing it down).

This is reflected in US five-year forward inflation expectations. The market thinks that inflation in America will be 1.8% in five years’ time, below the Fed’s 2% target, below the post-1948 average of 3.5% and barely above the 1.6% average of the past, post-crisis decade. Since inflation is in many ways about perception, this is a big thumbs down to 10 years of unorthodox monetary policy in the form of zero (or negative) interest rate policies (ZIRP and NIRP) and quantitative easing (QE).

But central banks are also worrying about growth in a world when America and China are at daggers drawn over trade and tariffs are becoming the order of the day. Bond markets are responding to this by anticipating rate cuts and reflecting the failure to generate inflation.

As the table shows, 10-year benchmark government bond yields are lower than they were a decade ago, as we emerged from the financial crisis, and lower than when the Greek crisis was at its height in 2012. Again, this can be seen as a big raspberry to central banks and their growth and inflation policies.

Policy pickle

The issue that investors must ponder now is whether central banks can succeed by trying more of the same monetary medicine that has singularly failed to galvanise their patient economies (at least on a sustained basis) since 2009. The experiences of this century would perhaps suggest not, according to the bond market at least since yields on 10-year government paper have consistently trended lower since 2000 (if not the mid-1980s).

Not that this seems likely to stop them from trying and this is the hard bit for investors when it comes to portfolio construction and asset allocation.

Is the (renewed) slide in bond yields down to fears of deflation, or at least the abandonment of hope that central banks can stoke growth and inflation?

Or is it that bond market participants are just anticipating more NIRP, ZIRP and QE and doing their buying before the central banks do theirs?

In either of these two cases it is possible to argue that US 10-year Treasuries still look good value, even with a yield of around 2%. Markets are putting an 84% chance on the Fed’s target interest rate coming in below 2% by April 2020.

But what happens if inflation does come back and central banks simply refuse to give in, cutting rates to zero (or beyond) and unleashing more QE? Government bonds would then be a horrible place to be, given where yields are right now.

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