Bank of England and ECB act to boost economies

 

The Bank of England and its eurozone counterpart today took emergency action to breathe life into their struggling economies.

The UK economy - threatened by the deepening crisis on the continent - received a £50 billion injection from the Bank as the country struggles to emerge from recession.

In Frankfurt, the European Central Bank (ECB) cut its key interest rate to a record low of 0.75% amid signs the 17-nation currency bloc contracted in the second quarter.

The action comes after a period of escalating turmoil in the eurozone, which has seen borrowing costs in countries such as Spain and Italy climb higher.

But economists questioned how much further central banks can go to help.

Tim Ohlenburg, senior economist at the Centre for Economics and Business Research, said: "Central bankers need to reach deep into their toolbox to find ways of propping up prices by somehow stimulating economic growth.

"With quantitative easing bringing little effect and interest rates near rock bottom, it's likely that new tools will be devised in due course."

The measures provided an initial boost to world markets but the rally was shortlived. Both the pound and the euro weakened.

The Bank - which also held interest rates at 0.5% - said its decision came as the eurozone crisis weighed on confidence and hit some of the UK's main export markets.

The UK's economy has barely grown for a year and a half and it warned the weak outlook meant "the margin of economic slack is now likely to be greater and more persistent".

It said inflation, which fell to 2.8% in May, was in danger of slipping below its 2% target and its stimulus measures should help sustain a gradual strengthening in output.

The gloomy assessment came amid signs the economy deteriorated in June as industry surveys showed that the construction sector went into reverse and the powerhouse services sector suffered its worst performance for eight months.

Most economists think gross domestic product - a broad measure for the total economy - fell slightly in the second quarter of 2012, following declines of 0.4% and 0.3% in the previous two quarters.

But while business body the CBI said today's QE may boost confidence, the stimulus package was criticised because it will hurt pensioners by pushing down annuity rates and may also push up inflation.

David Kern, chief economist at the British Chambers of Commerce, said the effect of QE will be "marginal" and "could be counter-productive".

He said: "It may limit the decline in inflation in the long term, at a time when we need falling inflation to underpin real incomes and boost demand in the UK economy."

He called on the Treasury to set up a bank specifically to lend to businesses, and said new schemes to encourage banks to lend money to businesses must be implemented quickly and forcefully.

Howard Archer, chief economist at IHS Global Insight, said there might still be more money printing to come, even though he thinks the economy will return to growth in the third quarter of this year.

He said: "We certainly would not rule out further QE in the fourth quarter.

"The economy is likely to remain fragile and prone to relapses, especially if there is not any sustained marked easing in the eurozone's problems.

"So it is very possible that the Bank of England will decide that more support is warranted for the economy, particularly if inflation heads down further."

Some economists think the Bank's QE programme could eventually be expanded to £500 billion.

Meanwhile, the ECB's rate cut came amid signs that even the powerhouse German economy contracted in the second quarter as the debt crisis drags on.

European leaders last week agreed on new steps to try to get to grips with the crisis, including allowing banks to get direct bail-outs from central rescue funds.

The cut in the refinancing rate could mean lower borrowing costs for banks, businesses and consumers.

The rate is what banks pay the ECB for loans and through them influences many other rates in the economy. In theory, cheap borrowing makes it easier for businesses and people to decide to spend, but some economists say it may have little effect since interest rates are already very low.

China's central bank, meanwhile, cut interest rates for the second time in a month to shore up its economy, the second-largest in the world, as growth is also slowed by developments in the eurozone.

The Bank's quantitative easing programme now stands at £375 billion.

PA

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