Washington, D.C., November 7, 2014 - The divergence in G-3 monetary policies took more definite shape in October according to the Institute of International Finance's latest Capital Markets Monitor. Central banks' generous injections of liquidity have allowed asset values to increase while providing a key source of support for economic recovery. However, the effect varies substantially among the G-3 changes in central bank balance sheets.

Fed Balance Sheet Growth

The IIF highlighted that U.S. equity prices have risen in correlation with growth in the Fed balance sheet. However, prices tended to decline or stall whenever the Fed balance sheet ceased expanding, as in the periods between QE's. The IIF warned that it remains to be seen whether recent improvements in the labor market and strong, above-trend GDP growth in the past two quarters will allow the U.S. economy to continue moving forward without relying on ever-increasing injections of liquidity by the Fed.

ECB Balance Sheet Changes

The IIF noted that the picture is quite different in the case of the Euro Area. The IIF emphasized that there appears to be little relationship between changes in the ECB balance sheet and the performance of regional equity markets, as measured by the Euro Stoxx index. In fact, the IIF indicated that the correlation between the Euro Area equity prices and the ECB balance sheet is much lower than the Euro Stoxx and the S&P 500 indices - suggesting that provision of USD liquidity has had a stronger impact on Euro Area equity markets than has provision of EUR liquidity.

BOJ'S QQE - Shock and Awe

The surprise decision by the BoJ to accelerate its Qualitative and Quantitative Easing program helped boost Japanese equities by more than 5% since the end of October. The renewed QQE needs to sustain its regained credibility in order to support further gains in Japan's equity market, the IIF said. The IIF noted that the Nikkei index has moved sideways since late 2013 until recently after rising by over 80% since late 2012.

Despite the early successes, the IIF warned that the apparent loss of impact on expansion in the BoJ balance sheet on equities reflects the travails of the Japanese economy since late 2013. Similarly, the sharp fall of the yen following the BoJ's announcement of acceleration in QQE could accelerate the yen's decline.

Overall, based on the US experience, monetary accommodation needs to be reinforced by other arrows of policies, including fiscal measures, to be effective. Otherwise the main impact of divergent monetary policy moves may be in further weakening of the Euro and yen, eventually leading to friction among the G3.

The Institute of International Finance is the global association of the financial industry, with close to 500 members from 70 countries. Its mission is to support the financial industry in the prudent management of risks; to develop sound industry practices; and to advocate for regulatory, financial and economic policies that are in the broad interests of its members and foster global financial stability and sustainable economic growth. Within its membership IIF counts commercial and investment banks, asset managers, insurance companies, sovereign wealth funds, hedge funds, central banks and development banks. For more information visit www.iif.com.