Bank waits but the City expects more drama next month

Speculation that weak economy will force another round of quantitative easing
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The Independent Online

Speculation is mounting that the Bank of England may be preparing for another substantial increase in its quantitative easing programme, or QE, even though the Bank's Monetary Policy Committee (MPC) announced no immediate change in policy at its regular monthly meeting yesterday.

The MPC also voted keep its Base Rate at 0.5 per cent, where it has stood since March, an all-time low in the Bank's 315-year history. In its statement, the MPC said that the Bank expected to compete its current QE programme next month. As of the start of this month, the Bank has spent £158bn of its current £175bn "budget" for buying gilts and smaller quantities of corporate bonds and commercial paper.

After the shock announcement of a £50bn extension of QE in August, and the revelation that three members of the MPC, including the Governor of the Bank, Mervyn King, voted in a minority for an even bigger extension on that occasion, observers have suspected that it might only be a matter of time before the Bank judged that another injection of cash would be required. It will be needed, they think, to boost growth and bring inflation back to its 2 per cent target over the next couple of years.

Last month's decision to keep rates and QE on hold was unanimous, but the minutes of the MPC meeting noted some members argued for an increase. Since then a string of weak data on the real economy, especially in manufacturing, has indicated that the economy may stage an even slower and feebler recovery than previously feared. The National Institute of Economic and Social Research said this week that the economy did not grow at all in the three months to September, having been in decline for the previous five quarters.

November is regarded as being a more likely month in which to revise policy, as the Bank's quarterly Inflation Report is published soon after the MPC meeting, and the Bank can set its decision in the context of its latest forecast on inflation and growth.

Arek Ohanissian, an economist at the analysts CEBR, said: "The MPC statement implies that there may be an extension to the current QE limit announced at the next meeting. The MPC will soon need to decide whether or not it will extend the current quantitative easing programme beyond the currently authorised £175bn. Our view is that it will indeed do so in an effort to provide further stimulus to a weak recovery. Moreover, impending tightening of fiscal policy... will give further impetus to continued loose monetary policy. In this case, the Bank can credibly project to keep interest rates low for the near to medium term. The question arises, however, what will happen when inflation eventually begins to rise?"

In its public statements, the Bank has made modest claims for QE but is certainly of the view that it is working. The Bank believes that in purchasing gilts and, thus, pushing their yields down investors have been encouraged to switch to corporate bonds and equities, which has helped companies raise capital, as the recent wave of rights issues and the record rise on the FTSE 100 Index since its nadir in March demonstrates. However such improvements have been largely to the advantage of larger firms able to access the capital armlets. Smaller companies and householders have seen less direct benefit, and there is less evidence that QE has directly improved lending by the banks.

Some observers remain sceptical about the effectiveness of QE. Colin Ellis, an economist at Daiwa Securities, said: "The problem is the MPC may think that QE is having more impact than it is. Yes, credit markets have improved markedly since March – but that has been a global phenomenon. Even where firms have taken advantage of this improvement to issue debt or equity, they have done so to restructure balance sheets – not to increase investment. Of far more concern is the link between financial markets and the broader economy. There is precious little sign of this transmission yet."

A £75bn programme of asset purchases financed by new central bank reserves was launched in March 2009. The programme was increased to a total of £125bn in May and to a total of £175bn in August.