Markets must listen to central bankers’ green conversion

Central banks move markets; financial analysts pore over every speech and every word from top policymakers, seeking clues about possible shifts. Investors should therefore take heed that central banks are increasingly turning green.

Christine Lagarde has argued that she wants to make climate change a “mission critical” priority, in her presidency of the European Central Bank. Mark Carney, the outgoing governor of the Bank of England, described shifting global temperature patterns as “the tragedy of the horizon” in a speech five years ago.

And this is not just happening in Europe. The San Francisco arm of the US Federal Reserve hosted its first conference on climate change last November.

So far, many of these discussions among central bankers have centred on the possibility that climate events could generate short-term disruptions.

Investors have understood that to mean either a shock to short-term macroeconomic activity — in the event of a flood, for example — or a risk to financial stability, as banks and insurers pay out for climate-related claims.

But to think of it solely in those terms is to miss the point.

Central banks are tasked with maximising aggregate demand, relative to supply constraints, to ensure that inflation sticks close to a specified target.

For much of the past decade, central banks in the developed world have struggled to generate sufficient demand and have, as a result, consistently fallen short of their inflation targets. Nowhere is the deficiency of global demand, relative to supply, more clear than in the oil price.

The price of a barrel of Brent crude has now dropped about 15 per cent since the start of the year.

Concerns about running out of oil have been very wide of the mark — it seems that we have more than plenty of it. With such downward pressure on inflation, most central banks will probably embark on new monetary experiments to lift demand to encourage more spending and more consumption. And, along with all that, more carbon emissions.

Therein lies the problem.

The inflation objective sits in stark contrast with another increasingly important aim of governments: how to tackle climate change more decisively. If the current inflation objective does not easily sit with an environmental objective, what is the scope for alignment?

In the UK, the BoE’s formal mandate provided by the government is to maintain price stability, first and foremost. The BoE is then tasked with supporting the economic policy of government, including growth and employment objectives. It is not too much of a stretch to see the prevention of climate change becoming a third objective.

It would not be the first time that the central bank is being asked to have a say on the type of growth it is delivering. Central banks are increasingly being asked to deliver growth that is “balanced”. So in the fullness of time, we should expect central banks to be asked to deliver stronger, yet greener, growth.

What would this mean, in practice, for central bank policy and markets?

The most obvious implication for policy would involve a reorientation, and perhaps an extension, of various asset purchase programmes. This would directly support public and private spending required for the type of green infrastructure necessary to shift to a zero-carbon economy. This would abandon the principle of “market neutrality” that has governed the purchases of assets until now.

For some, this may stray too much towards the realm of “helicopter money”, or could blur boundaries between monetary and industrial policy. But, in reality, it is not a significant departure from where we are today, with the central bank effectively providing low or zero interest loans to governments and corporates.

The ECB is likely to be the first to begin actively targeting its purchases. Why do we think this? First, the asset purchase programme is ongoing and, if anything, will need expanding (even though the supply of German Bunds available to buy is dwindling).

Second, there is considerable political momentum behind the European Green Deal, which is the hallmark policy of the new European Commission. And third, the Commission is closest to having a designated system to classify assets. In other words, the ECB would have clear guidance as to what assets it ought to be buying to meet environmental objectives.

Many investors are beginning to recognise the importance of the shift in environmental, social and governance initiatives, and how it might alter the economic and investment landscape.

But, even those that are relatively ahead of the game seem to be underestimating just quite how transformative central banks’ interventions are likely to be. Actions by central bankers look likely to turbocharge the climate change agenda.

Karen Ward is chief market strategist for Emea at JPMorgan Asset Management