6th November 2009

The Bank of England raises quantitative easing by £25bn

The Bank of England's Monetary Policy Committee has just announced that it is increasing its quantitative easing (QE) programme by �£25bn to a total of �£200bn while at the same time maintaining interest rates at 0.5% for the 8th successive month. In order to expand the programme it was necessary to get the permission of the Chancellor reflecting the fact that the recovery has proven slow to come through, and following much weaker than expected GDP numbers for the 3rd quarter that showed the UK economy is still firmly in recession.

Following the disappointing growth data the extension of the QE programme was not a surprise; indeed many observers felt that it may be raised by �£50bn, as has been the case in the past. Therefore, the MPC is signalling that is it slowing down its monetary stimulus and is in wait and see mode before deciding if it needs to inject more stimulus via QE at a later date. The next GDP numbers, that are due out in January, will give an indication of the Bank's intentions and following the recent Purchasing Managers Index figures (and indication of manufacturing strength) there is increased optimism that the UK economy should be emerging from recession. However, following last quarter's surprisingly poor data nothing can be taken for granted!

Of more relevance to the UK economy, and therefore the markets, is whether QE is working and how the Bank plans to exit having pumped billions of pounds into the economy. If the continual injection of liquidity fails to show an improvement in bank lending, reflected in paltry growth in the broad money supply (M4), then there is a danger that, in the words of Economist John Maynard Keynes, the MPC is "pushing on a string". This means that the stimulus is proving impotent in generating demand and growth, and the lack of broad money supply growth and lending highlights the residual concerns about deflation.

It is, therefore, vital that the MPC communicates effectively how it expects its QE programme to work in stimulating recovery because the impression is that it is not proving effective except in providing a fillip to risk asset markets. It is like filling a car with more and more petrol when the engine is broken. The Committee should detail how they propose to get the commercial banks lending again and for the broad money supply to grow which is a necessary condition for broad and sustainable recovery. Also, given the huge amount of money being created by QE (about 17% of GDP) we need to know the strategy the Bank proposes for exiting the programme that is, in theory and potentially in practice, highly inflationary.