What is notable here is not the bank rate being held but the decision, not only to continue with Quantitative Easing up to the agreed level of £150 billion (a further £25 bn) but to increase the maximum to a new high of £175 billion (£50 bn more than now).
My first comment is that this is madness. This is Mugabe’s route in Zimbabwe, “Keep the natives quiet - just print more money. We’ll never have to pay it back” . This is stoking up debt beyond reclaim and adding future inflationary pressure.
The second observation is that the BoE has decided that all those ‘green shoots’ are rank weeds. They think the banking crisis, let alone the economic crisis behind it are far from over.
[I wrote the above based on Sky News report. Since then I have Edmund Conway in the Telegraph’s reaction. He seems satisfied with the analysis of continuing problems and the bank’s actions]
The nail-biting goes on it seems for at least anothr quarter1
Christina
SKY NEWS 6.8.09 1:28pm
Interest Rate Held As Bank Pumps In £50bn
The interest rate was held at 0.5% today as the Bank Of England pumped another £50bn into the economy.
The Monetary Policy Committee (MPC) voted to hold interest rates at their record low and increased quantitative easing to £175bn.
The decision to pump in extra cash underlines the caution among policymakers over the strength of the UK's recovery from recession despite recent positive signs.
Official figures and surveys have shown manufacturers and services firms are emerging from recession, while house prices have also risen.
Economists expect the UK to return to growth between July and September but problems in the banking sector could still restrain a recovery.
Official estimates showed a disappointing 0.8% fall in output during the second quarter of this year.
In a statement explaining the surprise move on QE, the Bank said the recession "appears to have been deeper than previously thought".
While the pace of decline has slowed and business surveys suggested the low point in activity was "close at hand", money growth remains weak, the Bank said.
"Though there are signs that credit conditions may have started to ease, lending to business has fallen and spreads on bank loans remain elevated," it added.
The Bank said: "On the one hand, there is a considerable stimulus still working through from the easing in monetary and fiscal policy and the past depreciation of sterling.
"On the other hand, the need for banks to continue repairing their balance sheets is likely to restrict the availability of credit, and past falls in asset prices and high levels of debt may weigh on spending."
It added: "While some recovery in output growth is in prospect, the margin of spare capacity in the economy is likely to continue to grow for some while yet, bearing down on inflation in the medium term."
In an exchange of letters with Bank Governor Mervyn King, Chancellor Alistair Darling agreed to increase the QE threshold to £175 billion.
Richard Lambert, director-general of the CBI business group, said: "This must have been a finely balanced decision.
"The economic outlook has brightened a little in recent weeks, which might have argued for a pause in QE.
"But the MPC has been crunching the numbers for its quarterly inflation report, and must have concluded that a further policy stimulus was necessary."
Corin Taylor, senior policy adviser at the Institute of Directors, added: "The recession is not over yet, but it would be better for the MPC to call a halt once QE has expanded to £150 billion.
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TELEGRAPH 6.8.09
The Bank of England thinks the credit crunch is far from over
By Edmund Conway Economics Editor
The City’s money markets are still reeling. In the hours that preceded the Bank of England’s decision today, gilt traders and analysts seem to have convinced themselves that the Monetary Policy Committee would not extend its quantitative easing (QE) programme. The mass of positive economic data over the course of the past few weeks was such that they felt the MPC would conclude that by spending £125bn of newly-created central bank money it had done enough to yank Britain out of recession.
In the event the Bank decided otherwise, plumping not just to extend QE by £25bn to the £150bn initial ceiling agreed with the Chancellor, as I suspected - see my blog from earlier this week - but to go one notch further and raise it to £175bn. You can see the shockwave this sent through gilt markets as a result . The pound has also taken a major dive, having recently hit new peaks amid the speculation that QE may soon draw to a close.
The benchmark 10-year yield gilt today: having risen consistently in recent weeks, it plunged following the decision. More BoE purchases means more demand for gilts, which pushes their prices up but, by association, knocks their yields lower.
How QE works
Regular readers will be well aware of how QE works, but for the rest of you, the gist is as follows: the Bank is buying large amounts of bonds off private investors and paying for them with newly-printed money (except that the money is created electronically and goes straight into the banks’ accounts). It has opted to spend the vast majority of the cash on government bonds - gilts - since they are the most freely available and safest investment out there. The impact is threefold: first, it increases the amount of cash flowing around in the economy; second, this extra cash should persuade the investors to get out there and spend more on other investments; third, it reduces the interest rate on gilts, which in turn should bring down real borrowing costs throughout the economy. The first two will theoretically help the economy to start growing soon; the third helps counteract the deflationary forces in the economy. More on how QE works can be found at the Bank’s own site.
What does this decision mean?
The overarching conclusion is that the Bank is not convinced that the economy is in the clear. Hints of this can be seen from the statement produced alongside the decision (which is worth reading in full if you have time).
They say: “In the United Kingdom, the recession appears to have been deeper than previously thought. GDP fell further in the second quarter of 2009. But the pace of contraction has moderated and business surveys suggest that the trough in output is close at hand. Underlying broad money growth has picked up since the end of last year but remains weak. And though there are signs that credit conditions may have started to ease, lending to business has fallen and spreads on bank loans remain elevated.
“The future evolution of output and inflation will be determined by the balance of two sets of forces. On the one hand, there is a considerable stimulus still working through from the easing in monetary and fiscal policy and the past depreciation of sterling. On the other hand, the need for banks to continue repairing their balance sheets is likely to restrict the availability of credit, and past falls in asset prices and high levels of debt may weigh on spending. While some recovery in output growth is in prospect, the margin of spare capacity in the economy is likely to continue to grow for some while yet, bearing down on inflation in the medium term. But the recession and the restricted availability of credit are also likely to impact adversely on the supply capacity of the economy, moderating the increase in economic slack.”
None of that sounds like it’s describing an economy which is about to bounce back in a trampoline recovery. And this is quite right. As I wrote in my column this morning, there are still some serious concerns about the economy this year and next which have hardly been laid to rest by the recent pick-up in the housing market and in the surveys of the services and manufacturing sectors.
Moreover, the monetary figures (like M4) underline the fact that despite the massive amount of cash poured into the economy by the Bank, the shadow of deflation still hangs very heavy over the UK. Broad money - something which usually feeds into inflation a year or so hence - is still close to stagnant. This indicates that despite having put £125bn into the system and bought vast swathes of the gilts market, the Bank has not yet triggered the high inflation so many feared would be caused by QE. There are some important reasons for that - among them the fact that banks have so far failed to go out and use the cash injection to spend on investments. There may be some ways the Bank can fiddle with the QE scheme as necessary in the coming months to improve this.
In it to win it
But there is another reason the Bank has delivered this surprise. One of the objectives behind QE - one which over in the US the Federal Reserve has emphasised, though about which the Bank itself has been more reticent - is to get long term interest rates as low as possible. You need, if you’re fighting the deflationary forces of debt, to convince everyone that you will do whatever it takes to keep rates low for the foreseeable future (after all, the lower inflation/deflation is, the lower you need to bring borrowing rates). In recent weeks, the Bank has not succeeded in doing this: speculation about the impending end of QE has pushed long term interest rates (aka gilt yields) up to new highs.
By extending quantitative easing in this way, the idea is to leave the market under no doubt that you will do whatever it takes to bring gilt yields down - to cement the idea that it is “in it to win it”.
One further thing to note is the effect this will have on sterling. The weakness of the pound over the past year or so has been one of the best things that could have happened to the UK economy. True: it has made overseas trips more expensive, but it has also been a major boost to industry. The evidence is there to be seen from the recent purchasing managers index series on manufacturing and services. The UK is recovering far quicker than the US or eurozone, according to these surveys, something which is little doubt connected to the sterling depreciation (as well as measures like QE). The risk in recent weeks had been that this depreciation would have been “stolen away” from Britain before the recovery had really taken root. The extension in QE will help lessen that effect.
The end is still almost nigh
But one point to make which may be lost amid all the excitement about this extension is that the pace of the gilt purchases is already lessening. The Bank said it would spend the final £50bn over the course of the next three months. This is a slightly slower pace than they spent the first £100bn (averaging out at £25bn a month). At some point QE will need to end, and although that moment clearly won’t be until autumn or thereafter, eventually, when the economy displays what the MPC judges are more convincing signs of recovery, the programme will be wound up - though there is still a question mark over how soon it sells back these gilts to the market - if at all. We will learn more about the Bank’s plans in next week’s Inflation Report - its quarterly opportunity to brief the markets on its forecasts and thoughts about the economy. It will be an interesting session.
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