QE and rate cut as central banks play stimulus card

Bank of England to print £50bn as ECB interest rates hit historic low
  • @Benchu_

Central banks responded to intensifying economic storms yesterday as the Bank of England announced it will recommence its money-printing programme and the European Central Bank cut its interest rates to a historic low.

The Bank's rate-setting Monetary Policy Committee said it would purchase a further £50bn of government bonds over the next four months to stimulate demand. Meanwhile, the Frankfurt-based ECB voted to cut its interest rates by 25 basis points to 0.75 per cent. The ECB's president, Mario Draghi, said the decision was taken unanimously by the bank's board.

The MPC justified the extension of its quantitative easing programme (QE) by pointing to weak domestic growth and "heightened tensions" in Europe. It also said that the scale of the programme will be kept under review, raising the possibility of more QE later this year if the economy fails to recover.

"We welcome today's decision," said Philip Shaw of Investec. "Clearly the UK economy is struggling and faces an uncertain outlook, not least due to the situation in Europe."

But other analysts were sceptical over how much good more asset purchases would do.

"We continue to have doubts over how successful extra QE will be, but seeing as the Bank has few other options we expect them to stick with it," James Knightley of ING said.

The Bank's QE move was widely expected in the City of London after the nine-member MPC voted last month by the narrowest possible margin against restarting its asset purchase programme. Since then economic indicators have disappointed. This week the regular Markit/Cips surveys of the manufacturing and construction sectors pointed to a big decline in June, with the latter falling at its quickest pace in two and a half years.

The survey of the services sector, which accounts for 75 per cent of the UK economy, showed growth slowing to a crawl.

City analysts now expect UK GDP to contract again in the second quarter of 2012, having fallen by 0.3 per cent in the first three months of the year, and by 0.4 per cent in the final three months of 2011.

The ECB's rate cut was also widely expected, following a series of economic indicators showing that the eurozone economy is stagnating, with some nations, such as Spain and Italy, already deep in recession. As well as cutting its main refinancing rate to 0.75 per cent, the ECB reduced its deposit rate from 0.25 per cent to 0.

This is the rate that the ECB returns to eurozone banks when they park their reserves with it.

By slashing this payment, the ECB is trying to increase the incentive for eurozone banks to increase lending flows to other banks and the real economy.

However, Jennifer McKeown of Capital Economics, said the ECB's interest rate cuts were unlikely to have much impact on the eurozone crisis.

"[It] does little to alter the bleak picture … with effective overnight interest rates already at just 0.3 per cent, the effect of the cut on the wider economy is likely to be limited," she said.