UK recommences quantitative easing, holds rates at 0.5%

Sterling and gilt yields have dived following the surprise announcement by the Bank of England today it is increasing its quantitative easing programme by £75bn.

The benchmark 10-year gilt yield was at 2.36% before the announcement, but fell to 2.26% as the Bank raised its total asset purchase programme by £75bn to £275bn.

The BoE also kept interest rates at a historically low 0.5%, first set back in March 2009.

Peter Hensman, global strategist at Newton Investment Management, said all eyes would now be on the European Central Bank’s own rate decision today.

“Markets will concentrate on whether this proves to be part of a coordinated global response to the increased financial tensions, not least whether the ECB follows suit and eases monetary policy after its regular policy meeting.”

Sterling fell against the US dollar, and the FTSE 100 was up 2.3% at 5,219 on the BoE news.

Royal London’s chief economist Ian Kernohan said the market was expecting governor Mervyn King would hold fire on more QE until next month, as data earlier this week revealing the UK services sector grew in September.

“The figure of £75bn is not a huge surprise, the number £50bn was sounded out a lot prior to the announcement, but the market anticipated it would be between £50bn and £100bn,” Kernohan said. “With the positive data published earlier this week, many people in the market thought the Bank of England would wait another month.”

Invesco’s John Greenwood warned further QE in the UK is unlikely to lead to a rebound in economic growth as there was “no quick fix” to the economic woes. “In light of the Japanese experience of 2001-2005 and the recent US experience with QE, we should not expect the strategy to lead to any rapid recovery in the economy.

“Increasing the government’s indebtedness, or persuading non-financial companies to borrow more, would ultimately only weaken the economy, not strengthen it. We must expect a prolonged period of debt work-out,” he said.

Revised figures released this week show the UK economy managed just 0.1% growth in the second quarter – against a previous reading of 0.2% – whilst first quarter growth was revised down to 0.4%.

Up until now arch-dove Adam Posen has been the only MPC member to argue for a new injection of monetary stimulus.

The new round of QE suggests the Bank has put inflationary concerns on the backburner as fears mount the UK could be on the verge of a double dip recession. Inflation, as measured by the CPI, currently stands at 4.5% – more than double the Bank’s 2% target.

In his latest quarterly outlook Invesco’s Greenwood said he fears Germany, “the eurozone powerhouse”, is teetering on the brink of recession, and Italy and Spain are both “too big to fail, but also too big to be saved by the €440bn EFSF.

“The only solution is to have a very large, credible lender of last resort. The ECB, reluctant to depart from the principle of sterilising all sovereign bond purchases, has essentially ruled itself out. It requires a separate entity that can easily absorb all of Italy’s borrowing needs as well as those of Spain, Greece, Portugal, Ireland and possibly Belgium too.

“In the words of Hank Paulson, it requires a “big bazooka” with access to trillions of euros. Nothing else will restore credibility. Over the next few weeks the eurozone leaders must therefore commit to backstop the eurozone with a facility that is several times larger than the current EFSF.

“If they do not, or if they hesitate, some states may lose the ability to refinance their debts and the eurozone and many other leading economies will be plunged into another deep, protracted recession.”

Greenwood also criticised Operation Twist in the US, calling it a “highly dubious strategy” as will not stimulate markets like QE, could be counteracted by private portfolio adjustments and depress banks’ interest margins through its impact on mortgage and other lending rates.

The economist had a few positive notes to make on the emerging economies which he said are in better shape having been through balance sheet recessions in the 1990s and early 2000s but inflation has reached “uncomfortable levels”.

“Also, emerging economies remain critically dependent on exports to the developed world, and this implies an unavoidable slowdown in their growth trajectories not only in the next three months, but in the year ahead. Despite a few small tentative steps towards decoupling, little was ever achieved. The emerging economies remain tied to the fate of their developed trading partners.”


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