In response to a worsening global and domestic economic outlook, the Bank of England has announced that it will inject £75 billion of new money into the financial system. While the corporate lobby has welcomed the move, economists and analysts are sceptical about whether it will have any meaningful impact.
The theory behind quantitative easing is that in times of stress, banks and other investors buy into safe haven assets, such as gilts. The central bank prints money and uses it to buy back gilts, freeing up capital for investment into other assets - ideally through banks lending to small- and medium-sized enterprises.
Critics of the method say that the money is often either held as cash or reinvested in risk assets, such as equities, and is very slow to make its way into the real economy.
There is still an argument over whether the first £200 billion round of QE worked. The Bank of England (BoE) said in September that by its own analysis the asset purchase programme, which ran from March 2009 to February 2010, contributed two per cent to gross domestic product (GDP) growth and 1.5 per cent to inflation.
“I think it did [work],” Graeme Leach, chief economist at the Institute of Directors, told the Huffington Post UK after the bank’s announcement. “I think it’s an unorthodox medicine for the economy, but the patient is so sick, and sometimes you need to use unorthodox treatments, even when you know there are side effects. Last time around we were saved from the risk of deflation. The money supply would have been much lower than it probably was ... and that would have slipped us into a debt, deflation, depression scenario.
“I think it will work this time as well. At the moment we’ve got near-zero GDP growth, we’ve got near zero expansion in the money supply.”
However, how the money freed up through QE will be redeployed remains in question, and economists and investors seem much more uncertain as to its benefits.
At Coutts, global head of economics and asset strategy Carl Astorri said that, while some form of stimulus was clearly needed, this basic QE is unlikely to have the desired effect.
“With the UK economy dead in the water, the MPC has finally seen sense and reopened its asset-purchase scheme,” Astorri said.
“Unfortunately, the MPC is repeating the mistakes of the past and buying gilts rather than buying corporate bonds or intervening to improve the flow of lending to credit-starved households and small businesses. Until it does, it will continue to get little bang for its pound.”
“I think it’s a natural antidote to the fiscal austerity that’s been imposed by the government,” Alan Wilde, head of fixed income and currency at Baring Asset Management, said. “They want to stick to plan A and the Bank of England has got to do its part to try to ease monetary policy. I think when UK rates are as low as they are, I’m not sure there’s much lower for them to go, so I’m not sure what the overall effect of this is going to be.”
“The corporate sector, ex-financials, has pretty healthy balance sheets,” he added. “The problem is a lack of confidence, not a lack of money to finance investment. Really, the missing ingredient in my view is confidence, rather than cash.”
Furthermore, the move could have side effects, Wilde said.
“It makes the pension deficits even wider, because it forces down interest rates, and to that extent I think that’s an unhealthy side effect,” he said. “The second thing I think it might do is that it might encourage the international sector, who have allocated money to gilts over the last 12 months because of all the goings-on in Europe, to crystallise some profits sooner than might otherwise be the case.”
While the announcement may have some marginal impact on anaemic domestic growth, it is far from a solution to the bigger concerns that are overshadowing the UK economy. The threat of the sovereign debt crisis in the eurozone turning into a wider financial system failure remains strong.
The European Central Bank (ECB) today held interest rates at 1.5 per cent, despite a widespread desire in the market to see them trimmed back to help the single currency area beat its current growth slump. The ECB also announced that it would restart its covered bond buying programme, as the problems in the periphery show signs of creeping into the core.
It is the worry that an unmanaged default by Greece and the subsequent turmoil in other eurozone members would trigger a banking crisis that would engulf the UK. In that context, it seems unlikely that the beneficiaries of the gilt buying programme would be willing to reinvest in risky assets.
“There’s really nothing that the Bank of England could do or can do to solve that problem. Is it going to stop a European banking crisis? No, because it can’t. It’s not a UK-centric problem,” Rupert Watson, head of asset allocation at Skandia Investment Group, said.
The move could, at least, improve confidence in the markets “at the margin,” Watson said, but overall the benefits are likely to be modest.
“In terms of what effect these purchases will have, I think you’re only talking about small, nought-point-something of what it will boost growth relative them to doing nothing,” he said.