Bank of England Shifts to Quantitative Easing

March 5, 2009

The Bank of England made a final rate cut of 50 basis points to 0.5% in its Bank Rate and indicated 1) that further reductions risked market harm but 2) a rate of 0.5% by itself would not likely return CPI inflation to its 2% target in the medium term.  The size of the rate cut was as analysts expected and brings the cumulative reduction to 450 basis points since early October and to 525 basis points since a peak of 5.75% for the five months to early December 2007.

A statement released by the central bank formally announced that quantitative easing would begin with the purchase over the next three months of Gbp 75 billion (about $106 billion worth) of financial assets (mostly medium- and longer-term gilts) through the issuance of central bank reserves.  This program has two goals: to stimulate the growth of the money stock and credit more directly and to thereby accelerate the growth of nominal spending.  The size of this program and a Gbp 150 billion limit on the facility are somewhat bigger than the Street was anticipating.  The buying of Gilts should depress real long-term yields.  Inflation is unlikely to adjust upward in this deflationary environment.  Quantitative easing as practiced here and by other central banks still falls short of the massive program that Japan conducted earlier this decade.  Japan’s experience was mixed.  That economy never returned to its pre-1991 form.  Investors will want see tangible and powerful improvement in economic performance before seeing quantitative easing as a panacea.

The description of economic conditions and prospects contained no surprises.  Credit has been tight, and every component of domestic demand is poor.  Sterling depreciation has begun to support net exports, but the steep rate of decline in the economy last quarter is projected to persist “in the early part of this year.”  Sub-target (<2%) inflation should commence in the second half of this year.

Minutes of today’s meeting will be published on March 18th.

Copyright 2009 Larry Greenberg.  All rights reserved. No secondary distribution without express permission.



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