Central Banks Tighten the Purse Strings A Little

The world’s central banks are easing up slightly on the generosity they have shown over the past year when the financial crisis threatened to destroy the global economy. After European Central Bank president Jean-Claude Trichet said his bank would withdraw some liquidity operations, the euro rose.  Similarly the pound went up after the Bank of England started purchasing bonds at a slower rate.  The Federal Reserve detailed the conditions in which it would raise interest rates – though it hasn’t acted on that yet.

Juergen Michels, chief European economist at Citigroup, Inc., in London, says that “As soon as the first exit measures are put in place, there’s the risk that the market overreacts.  We’ll probably see a tightening of financing conditions, and hard-fought-for improvements will be in jeopardy.”

These actions mean that investors will have to operate without the liquidity that has been propping up the world’s economies, even as new concerns about additional asset bubbles grow.  Mistiming the withdrawal of support could spoil the fragile recovery.  Central banks are changing course at a time when factories are restocking inventories, and the price of commodities like gold and sugar are climbing.  The MSCI All-Countries World Index has soared 66 percent since March and sugar has increased 90 percent this year.

“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 the central banks’ largesse, and neither do they.  They’re pretty nervous, but they’ve got to get out of it at some stage.”