Britain’s central bank surprises with expanded easing

By Reuters Staff
August 6, 2009

By David Milliken and Matt Falloon
LONDON, Aug 6 (Reuters) – The Bank of England took a far
bigger step than expected to boost Britain’s recession-hit
economy on Thursday, stunning markets by expanding its
quantitative easing plan to 175 billion pounds from 125 billion.

The central bank said Britain’s downturn appeared to have
been deeper than previously thought and, while the trough in
output was near and some recovery was on the way, tight credit
conditions would remain a considerable drag.

The decision shocked many investors who had been starting to
take a brighter view of the British economy, especially after
recent economic data suggested the year-long, steep recession
may have ended in the third quarter.

Economists had been split on whether the BoE would increase
its quantitative easing scheme, completed last week, or pause to
gauge what impact it was having. Few had forecast an expansion
above the original government-set limit of 150 billion pounds.

“This is a huge surprise,” said Ross Walker, UK economist at
Royal Bank of Scotland. “All the rhetoric seemed to point to not
doing very much more, even up to 150 (billion) seemed
odds-against after the better (economic) surveys.”

The pound fell more than a cent against the dollar and gilt
futures rocketed higher after the BoE’s decision, which also saw
interest rates kept at a record low of 0.5 percent.

Markets will now await the central bank’s quarterly
inflation forecasts — due next Wednesday — for a further
explanation of the decision.

“I would not want to say this is the end of it — if they
decide in three months’ time that the economy still needs more
stimulus they might actually do more,” said Jonathan Loynes,
chief UK economist at Capital Economics.

CREDIT CONCERNS
On a positive note, the BoE pointed to a stabilisation in
Britain’s main export markets, an easing in financial markets
and bank funding, and an improving consumer and business mood.

But Thursday’s move suggests the Bank’s new forecasts will
show inflation undershooting its two percent target due to the
deeper than predicted recession and big headwinds to recovery.

Finance minister Alistair Darling, approving the expanded QE
programme, said raising the limit would help the BoE to avoid
such an undershoot.

There have been concerns policymakers’ unprecedented efforts
to boost money flows through the economy by buying bonds with
newly-created cash may not be filtering down to credit-starved
businesses quickly enough.

“As has always been clear, it will take some time for the
full effect of the programme of QE to have its impact,” Treasury
minister Stephen Timms told Sky News.

The BoE, which says it could take about 9 months for the
impact of QE to become visible, said lending to firms had
actually fallen and spreads on bank loans remained high.

Analysts say it is really too early to tell if QE is working
yet but, with banks busy repairing balance sheets after the
worst financial crisis in living memory, policymakers will be
extra wary of any signs of a prolonged lending blockage.

For now, the central bank will continue its programme of
government bond purchases — started in March — for another
three months, with an expanded range of gilt maturities. The
scale of it will be kept under review.

The BoE had faced a dilemma at its Aug. 5-6 policy meeting.
Halting the QE process too early could prolong Britain’s worst
recession in decades, but doing too much risks setting the stage
for an inflation surge in several years time.

(Additional reporting by Fiona Shaikh; editing by Stephen
Nisbet)
Britain's Chancellor of the Exchequer Alistair Darling (file photo)

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