Bank monetary boost starts off successfully

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The first instalment of the Bank of England's £75bn "spending spree" passed off successfully yesterday, with a £2bn purchase of gilts through a "reverse auction".

The programme of quantitative easing – with a total of £150bn authorised and £75bn to be implemented over the next three months – is designed to increase the money supply, and boost demand and output in the economy. It was announced last week. Although UK pension funds and other institutions apparently declined to take part in yesterday's activities, the Bank was successful in attracting tenders of gilts from the commercial banks. In all, some £10bn of gilts were offered for sale to the Bank of England, leaving the offer comfortably oversubscribed.

The relatively lukewarm response from institutional, non-bank investors could be put down to the short notice the Bank placed them under in this first auction. However, the ambitious scale of the asset purchase scheme – representing an increase of 5 per cent in the UK's broad money supply – means that the Bank may have to offer increasingly attractive terms over the coming weeks and months to tempt them to join in. Jason Simpson, fixed income strategist at RBS, said: "There's obviously a lot of excess stock on the street and that is going to be the case for the first couple of weeks, but once that is removed, the Bank is going to have to pay successively higher and higher prices."

Gilt prices have soared since the Bank unveiled its plans last Thursday, when it also slashed interest rates to a record low of 0.5 per cent. (The Bank has said Bank rate is unlikely to be cut further.) As a consequence, yields on gilts earlier this week fell to levels not seen in half a century. Yesterday, gilt prices and futures extended their gains before falling back. The yield on benchmark 10-year gilts was nearly 4 basis points down at 3.068 per cent.

However, the proof of the success of the policy will be the extent to which the banks use their infusion of cash to resume lending to companies and households – and how much the banks simply "hoard". "The failure of the non-competitive auction to attract offers did worry markets for a while but the result of the competitive auction was very reassuring," Investec's chief economist, Philip Shaw, said. "What is going to concern us now is to what extent the money is going to find its way into the broader economy."

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