Bank of England launches second round of QE

The Bank of England's Monetary Policy Committee launched a second round of quantitative easing (QE) today, worth £75 billion as it maintained the base rate at its historic low of 0.5% for the 31st consecutive month.

The asset purchase will be rolled out over four months with the amount kept under review. It takes Britain's QE total to £275 billion to date.

The MPC’s decision to launch QE2 was prompted by concerns that “The deterioration in the outlook has made it more likely that inflation will undershoot the 2% target in the medium term.”

"The pace of global expansion has slackened, especially in the United Kingdom's main export markets. Vulnerabilities associated with the indebtedness of some euro-area sovereigns and banks have resulted in severe strains in bank funding markets and financial markets more generally. These tensions in the world economy threaten the UK recovery," the Bank said in a statement.

It noted temporary factors which were moderating the underlying rate of growth and said continued pressure on household income is likely to continue to weigh on domestic spending, as banks continued to show reluctance to lend money.

“While the stimulatory monetary stance and the present level of sterling should help to support demand, the weaker outlook for, and the increased downside risks to, output growth mean that the margin of slack in the economy is likely to be greater and more persistent than previously expected,” the statement continued.

The Bank believes inflation is likely to climb above 5% “in the next month or so” and pointed to the recent increase in CPI inflation, which rose to 4.5% in August, saying it reflected the increase in VAT at the beginning of the year, along with the impact of higher energy and import prices.

However, it added that inflation is likely to fall back sharply next year as the influence of the temporary factors diminished.

All eyes will be on the minutes of the MPC meeting which are due out on 19 October.

QE2 – the reaction...

The decision confirms that the MPC finally recognises that the major threat to the UK is renewed recession, not inflation, according to Jonathan Loynes, chief European economist at Capital Economics, who welcomed the move.

“We had thought that the MPC might wait another month until November - statistically the committee’s favourite month for policy changes - before acting. But recent gloomy news – not least yesterday’s data showing that the UK recession was deeper than previously thought – may have convinced a majority of members of the need to act without delay. The accompanying statement put emphasis on the implication that there is more slack in the economy than previously thought,” he said.

Azad Zangana, european economist at Schroders said the Bank’s swift action was designed to see off a double-dip recession and expects it to engage in even more asset purchasing once this round expires in February 2012.

“ONS figures released earlier this week showed that the recession had been deeper than previously estimated, while growth in recent quarters had also been revised down. In addition, the Bank of England is clearly concerned by the crisis engulfing the Eurozone – the UK’s largest export region,” he said.

“In our view, the restarting of quantitative easing will boost confidence and asset prices in financial markets, but we remain sceptical over its power to restart lending, and therefore have a meaningful impact on the real economy. Where QE might have an impact is on Sterling. If the purchases of assets leads to a depreciation in Sterling, then this could boost demand for UK exports. However, this would also raise inflation for households, who are already struggling to make ends meet.”

Jeremy Batstone-Carr, chief economist at Charles Stanley said the scale of QE2 was much bigger than anticipated and reflects the Bank’s view that a large amount of QE is required to make a difference to both the real and nominal GDP growth, given the impaired nature of the banking system. 

He notes that the previous round of QE (£200 billion asset purchases = 14% UK GDP) added just 2.25% - 3.5% to nominal GDP (split roughly equally between real GDP growth and inflation), a far smaller effect than imagined when the Bank’s asset purchase programme began in 2009.

“We believe that the Bank’s intention is to operate on sufficient scale so as to be able to drive long-dated yields lower.  Although short-dated gilt edged yields are close to zero , forward yields on long-dated gilt-edged are still fairly elevated (and well below the extreme lows of the early 1990s when a combination of budget surplus and the introduction of the Minimum Funding Requirement  resulted in a huge squeeze in long gilt-edged yields,” he commented.

But Batstone-Carr warned there are no quick fixes: “The Bank itself has stated that it believes that the boost from additional QE is fairly slow.” 

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