Bank of England to buy up corporate bonds to unblock markets

Governor outlines plans to buy £50bn of illiquid assets to free up flow of credit

The Bank of England will start buying up corporate bonds within weeks to unblock capital markets and free banks' balance sheets so that they can lend to support the economy, Mervyn King, the Bank's Governor, said last night.

In his first speech of the year, Mr King outlined radical plans for the Bank to buy up an initial £50bn of illiquid assets in the market to increase the flow of credit, with the option of ex-tending the scheme to boost the money supply by effectively creating new money. The asset purchases will come on top of a raft of other measures designed to get banks lending to limit the impact of the recession.

Mr King told a CBI dinner in Nottingham that the Bank was ready to use "unconventional measures" to boost an economy facing a marked contraction in the first half of this year after a sharp slowdown at the end of 2008. The bank's intervention in shattered credit markets could make key securities more liquid, reduce the cost of borrowing for companies and ease the strain on banks' balance sheets, he said.

Despite interest rates at an all-time low of 1.5 per cent after a series of big rate cuts, the Governor said the Bank's Monetary Policy Committee was in danger of undershooting its 2 per cent target for inflation. But he said the MPC was not yet ready to buy up assets without issuing Government debt, a so-called quantitative easing move that would amount to printing money. But the Bank's new Asset Purchase Facility will start buying up assets in the market "in a matter of weeks, not days", Mr King promised.

The Government is wary of taking on extra risk by buying corporate credit outright, and Mr King stressed that the Bank would only buy assets that played a key role in the financial system and for which there would be strong dem-and in normal conditions.

"There is a fine dividing line between helping to oil the wheels in markets that are temporarily impaired and artificially supporting markets in which there is no underlying demand," the Governor said. "Such asset purchases involve taking more credit risk on to the public sector balance sheet. That is why the Bank will consider purchasing only high-quality assets." He highlighted as potential purchases high-quality corporate bonds, whose risk spreads had been driven to their highest since the mid-1970s because of illiquid markets. Bank buy-ups of commercial paper could also ease that market, though it is less important in the UK than in the US, he added.

The Governor said Britain's heavily indebted economy faced a dilemma because short-term spending was needed to ease the impact of the slowdown, though in the long run the country needed to reduce borrowing and save more. But he said it was possible for banks to increase lending to the "real economy" while at the same time bringing down the volume of loans on their balance sheets.

Mr King also insisted the Government's latest banking bailout did not leave taxpayers dangerously exposed to banks' losses, and that the measures would restore order to the financial system. He defended the plan after another day of market turmoil. Banking shares fell heavily and sterling slumped on fears that the measures to guarantee banks' toxic assets would not be enough to prevent a deep recession.

"To be clear, the scheme does not mean that the taxpayer will bear the full brunt of past lending mistakes by banks," Mr King said. "Rather, there is a sharing of losses between shareholders and the Government – or coinsurance – with the Government providing, at a price, insurance against only extreme outcomes for the banks."

Mr King said: "No one can know at what point the impact of all this stimulus will have a visible effect on activity; the lags in economic policy are notoriously long and unpredictable. But well-designed policies implemented within a consistent policy framework will eventually work."

Poll: Respect for Bank plunges

The British public's respect for the Bank of England has plunged in the past month. An opinion poll run by the research group YouGov on behalf of PoliticsHome.com found that the central bank's rating among voters had sunk 15 points since December. A statement from PoliticsHome said: "This rapid deterioration may be seen as an indication that the public are frustrated that none of the action taken by the Bank so far has appeared to have any positive effect."

The website launched its Phi5000 opinion tracker last April, canvassing 5,000 voters. The opinion of the Bank of England was at zero until the start of the year, the survey found. As the economic crisis has deepened and the bank has failed to stimulate a recovery with its monetary policy, the balance currently sits at -15.