Bank hedges bets with QE expansion

November 5, 2009

BRITAIN-BANK/RATESWhen the Bank of England decided to expand its quantitative easing policy by 25 billion pounds to 200 billion on Thursday, it was essentially hedging its bets.

After Britain’s economy shrank unexpectedly in the third quarter, and with two thirds of the City expecting an expansion to the QE programme, simply shutting off the tap of government bond purchases would risk being more of a shock than the economy could bear.

On the other hand, the Bank clearly believes that the worst is over for the economy and that recovery will come soon — even if it’s going to be weak.

Thursday’s decision means the central bank will keep buying government debt until February, but at only half the pace of before. This still amounts to around 2 billion pounds a week, not including the much smaller sums of corporate debt that the Bank is buying.

What the decision means for a typical household is harder to calculate. The Bank says that its quantitative easing programme has raised the price of government and corporate
bonds, making borrowing cheaper.

But for average firms and consumers looking for a loan, the benefit is harder to spot.

There is little clear evidence that banks are much more willing to lend than a few months ago — though the Bank would argue that quantitative easing has been instrumental in avoiding the recession turning into a depression.

In the longer term, the big unknown is the impact that quantitative easing will have on inflation. Sterling’s weakness against the dollar and the euro will push inflation up in the short term, and going forward the Bank of England said it faced a balancing act.

While rising unemployment and half-full shops and factories will keep a lid on prices, policymakers know that quantitative easing could exert upward pressure on demand and prices for months if not years after it has stopped.

That’s why they took the decision today which could mark the gradual phasing out of this unprecedented policy of asset purchases.

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