What Is Quantitative Easing?
19 Oct
In October 2011, the Monetary Policy Committee of the Bank of England voted to inject £75 billion into the United Kingdom economy via a process known as quantitative easing. Here we examine what quantitative easing is and what the effects of the Bank’s decision might be.
The economy of the United Kingdom is to receive a £75 billion stimulus after the Monetary Policy Committee (MPC) of the Bank of England decided in October 2011 to carry out another round of quantitative easing, which effectively involves printing new money, in order to boost the ailing economy.
Sir Mervyn King, the Bank of England governor, described the economic climate as”the most serious financial crisis we have seen since the 1930s, if not ever.”
The additional money will be used to buy government bonds (gilts) from investment and pension funds, freeing up these funds to invest more in equities and other higher risk areas.
Initial reaction to the announcement appeared positive, with the FTSE 100 index gaining around 4% almost immediately.
The Bank carried out a £200 billion round of quantitative easing in March 2009, and this resulted in a great demand for UK equities from overseas buyers, and a rise of almost 2% in the UK’s Gross Domestic Product. But some analysts wonder whether the effect will be as great this time, especially given the universally low predictions for short-term growth in the economy. Some have suggested the money would have been better used to boost private businesses.
Perhaps the best known task of the MPC is to set the UK’s base interest rate. This rate has stayed at 0.5%, the lowest the Bank believes this rate can feasibly go, since March 2009. Recent Committee votes have been unanimous as to keeping the rate unchanged. Hence the Committee has been forced to examine quantitative easing as an alternative way of boosting the economy – there has been almost zero growth in the UK economy over the nine months to June 2011.
The announcement of the stimulus has reinforced a belief in the financial sector that interest rates will remain at 0.5% for some considerable time, and hence high street banks are setting rates on their own products on the assumption that a lengthy period of low interest rates will follow. This is bad news for savers whose account interest rates are often determined by the level of the base rate, but potentially excellent news for those considering a new mortgage, with some of the lowest fixed rate deals ever seen in the UK being offered as of October 2011.
The quantitative easing announcement could mean that pension annuity rates fall further. The last round of quantitative easing reduced the yields on government bonds significantly, thus reducing the annuity rates.
Injecting more money into the economy can raise inflation, especially if a period of low economic growth follows, and at the time of the announcement, the UK’s Consumer Prices Index stood at 4.5%, well above the Bank of England’s target of 2%. However, many analysts expect inflation to fall significantly in the coming years given the economic difficulties.
When the last round of quantitative easing took place, under a Labour government, George Osborne described the move as “the last resort of desperate governments when all other policies have failed.” Although the MPC is independent of government, the decision to carry out more quantitative easing has now occurred under a Conservative – Liberal Democrat coalition government, of which Osborne is Chancellor of the Exchequer.
