Savers must start becoming investors

May 8, 2009

david-kuo_motley-foolthumbnail- David Kuo is director at The Motley Fool. The opinions expressed are his own. -

The Bank of England Monetary Policy Committee decided to leave interest rates unchanged at 0.5 percent in May. This came as no great surprise given that the Central Bank has already slashed interest rates to a level where further cuts would have made no discernible difference to the cost of money.

That said, there are other ways to drive down the cost of money. In this regard, the Central Bank still has plenty of gunpowder left in its keg to blast the UK economy out of the doldrums. So far, it has only printed two-thirds of the 75 billion pounds of fresh money authorised by the Government for quantitative easing. It can pump in another 75 billion pounds into the economy after that. So, in total, it has 150 billion pounds in its armoury.

It can be argued that the Bank now has little choice but to continue pumping money into credit markets through quantitative easing given that cutting interest rates has not worked. After all, the problem that that UK faces is not the cost of money but instead the quantity of money.

Curiously, pumping 50 billion pounds into the credit markets has yet to have an effect on broad money growth. But at some point quantitative easing will increase money supply. However, it will come at a heavy price – inflation.

Of course inflation appears to be subdued at the moment, though this depends on which inflation index is used to measure the rise in the cost of living. The Retail Prices Index (RPI) has fallen to zero but the Consumer Prices Index (CPI) rose from 3 percent to 3.2 percent. The latter, which excludes mortgage costs, suggests that the cost of living is still going up at a time when consumers have little appetite to spend money.

The danger for consumers is that when Quantitative Easing begins to work, the surge of money and credit into the economy could boost inflation significantly. It is therefore vital that savers ensure they are properly invested in assets that keep pace with inflation.


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