The Bank of England (BoE) has announced another round of quantitative easing. At its meeting on 5th July the Monetary Policy Committee voted to pump ?50bn of extra stimulus into the
The Bank of England (BoE) has announced another round of quantitative easing. At its meeting on 5th July the Monetary Policy Committee voted to pump ?50bn of extra stimulus into the economy. At the same time the base interest rate was kept on hold at 0.5%.
The decision to launch this third round of quantitative easing ? ?QE3? ? was taken against a ?background of continuing tight credit conditions and fiscal consolidation? and ?the increased drag from heightened tensions within the Euro area?. The Bank said that although progress was made at the latest European Council, there are still concerns about debt levels in several EU countries. This is weighing on confidence and has hit some of the UK?s main export markets.
What is quantitative easing (QE)?
When interest rates are too low to be cut any more, a central bank can opt to pump money directly into the economy. Although QE is often described as ?printing money?, the bank does not actually do this, rather it basically credits its own bank account, thus expanding its balance sheet.
It uses this money to buy assets, usually financial assets such as government and corporate bonds. The institutions selling the assets (commercial banks or other financial businesses) then have new money in their accounts which they can lend to businesses and individuals. This boosts the money supply and should feed into the wider economy.
At the same time, when the bank buys bonds, it reduces the supply in the economy and so increases the demand for new bonds. This makes it cheaper for businesses to borrow money for longer-term investments, as long-term interest rates also get pushed down.
How much QE has the Bank of England done?
The QE programme was first launched in March 2009 with an initial ?75bn of asset purchases. Later that year it expanded the programme to ?200bn.
It announced a further ?75bn of QE in October 2011, dubbed ?QE2?. This was expanded by ?50bn in February 2012.
The latest round takes the total to ?375bn.
Does QE work?
The Bank believes it does. A BoE report found that the first round of QE had provided a ?significant? benefit to growth and that gross domestic product had increased by between 1.5% and 2% as a result. This is the equivalent of cutting interest rates by between 1.5% and 3%.
While some analysts point out that lending to businesses and individuals remains sluggish in spite of QE, others argue that it has helped the financial markets by keeping the interest rate on government bonds down.
While there is no way to quantify it, it is more than likely that the UK economy would have been in worse, perhaps much worse, shape without QE.
It does have it critics, however, with pension campaigners being particularly vocal, claiming it has contributed to company pension scheme deficits and has driven down annuity rates.
The BoE responded to this in May, with deputy governor Charlie Bean saying that since QE had raised share prices, it had a neutral impact on a pension fund.
Monetary Policy committee colleague David Miles also claimed that QE was not as damaging to pensions as suggested. The end result is more money in the wider economy. He explained that the sellers of government bonds tend to use some of the money they get from the BoE to purchase other assets, such as corporate bonds and shares. As demand for such assets increase so does their price. That lowers longer-term borrowing costs, and encourages the issuance of new equities and bonds by firms.
Is there anything different this time?
The QE programme will be working alongside other recently announced measures by the BoE and Treasury. A new Funding for Lending Scheme is about to be launched, and there are plans to ease liquidity regulations on banks. The BoE believes that these measures, together with reduced pressure on household real incomes because of lower commodity prices and the continued stimulus from past monetary policy actions, should ?sustain a gradual strengthening of output growth?.
What about the Eurozone?
On 5th July the European Central Bank (ECB) cut its key interest rate from 1% to 0.75% – a record low for the Eurozone. Markets had hoped for a cut to 0.5%, but this may still happen at a later date. The Bank also cut its deposit rate from 0.25% to 0% to boost bank lending to the private sector.
It stopped short of increasing its ?1 trillion funding facility for banks or launching a QE programme. President Mario Draghi did however hint that the Bank has more weapons ready to help the Eurozone. ?We still have all our artillery ready?, he said.
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By Bill Blevins, Blevins Franks Financial Correspondent
6th July 2012