October 6, 2011 / 11:09 AM / 7 years ago

UK launches fresh stimulus with cash boost

LONDON (Reuters) - The Bank of England has launched a second round of quantitative easing to defend Britain’s faltering economy against the euro zone debt crisis, pledging to buy 75 billion pounds ($114.8 billion) of assets with new money in a dramatic move to stave off recession.

Silhouetted workers walk in front of office towers in the Canary Wharf financial district in London February 16, 2011. . REUTERS/Luke MacGregor

Thursday’s decision by the BoE to expand its asset purchase program to a total of 275 billion pounds ($424 billion) highlights the precarious state of Britain’s economy as global growth slows, government spending cuts and tax hikes bite, and consumers face high inflation and slow wage rises.

In a letter to finance minister George Osborne seeking approval for the move, BoE governor Mervyn King said the global economic recovery was faltering and that the euro debt crisis had created severe strains on financial markets.

“These tensions in the world economy threaten the UK recovery,” King wrote.

While inflation is still expected to rise above 5 percent over the next months, the recent deterioration of the outlook had made it more likely inflation would undershoot the 2 percent target over the medium term, the BoE said.

Economists in a Reuters poll had reckoned there was only a 40 percent chance the central bank would restart its asset purchase program, or quantitative easing, this month, and most had only expected an injection of 50 billion pounds whenever it came.

The move puts the BoE ahead of other central banks in responding to a darkening global economic outlook and renewed market turmoil. Sterling weakened to its lowest in more than a year against the dollar, and long-dated gilt yields tumbled to record lows as markets braced for BoE asset purchases.

“Once again the BoE has made use of its secret weapon — shock and awe,” said Alan Clarke, an economist at Scotia Capital. “Pretty much everyone expected QE to restart at some point — but it was only a minority view that it would start this soon, or be in excess of 50 billion pounds. In doing so the Bank has achieved the most bang for its buck.”

Some economists said the central bank may eventually expand the total of its purchases to as much as 500 billion pounds.

The BoE has kept interest rates on hold at a record-low 0.5 percent since March 2009, unlike the European Central Bank which raised them twice this year. The UK central bank bought 200 billion pounds-worth of assets with from March 2009 to February 2010.

ECB head Jean-Claude Trichet failed to give any clear hint of upcoming rate cuts at his last media conference after holding rates steady at 1.5 percent, although he announced further liquidity streams for struggling banks.

CREDIT EASING

The BoE’s move to buy more government bonds with new money was welcomed by the government and businesses, but the boost it will provide to the economy is far from certain given bond yields are already at record lows.

Osborne voiced confidence on Thursday, saying: “The evidence shows that it (QE) will help keep interest rates down and boost demand and that will be a help for British families.”

However, some economists say it is the bleak economic outlook and lack of demand preventing businesses from investing and consumers from spending, not the lack of cheap credit.

In a move to address some QE shortfalls, Osborne on Monday announced a scheme of credit easing to funnel lending directly to companies starved of credit by banks.

“Given evidence of continued impairment in the flow of credit to some parts of the economy, notably small and medium-sized businesses, the Treasury is exploring further policy options,” Osborne said in a response to King’s letter.

While businesses and economists in general applauded the idea, such a scheme would be more a medium-term help for small- and medium sized firms than a quick fix for the economy’s woes.

The opposition Labour Party’s finance spokesman, Ed Balls, said QE was unlikely to be a big help to an economy hit by government spending cuts.

“With confidence depressed, it’s very hard for monetary policy to make a difference. It’s like pushing on a string,” he said in a BBC interview.

MORE TO COME?

Britain’s economy has basically flatlined over the past 12 months. With the government’s hands tied by its pledge to erase a budget deficit of some 10 percent of GDP, pressure has been mounting on the bank to do more to support the economy.

Meager growth in service sector output in July and a drop in new car sales in September published on Thursday added to a recent string of weak data.

A number of policymakers had flagged their readiness to join arch-dove Adam Posen and vote for more easing, after many saw the case for more easing strengthening at the September meeting.

Some economists expect much more to come.

“We would not be surprised to see the total asset purchase spend rise to 500 billion pounds, with this round of QE starting with today’s 75 billion pounds eventually adding a further 300 billion pounds to the QE1 total,” said James Knightley at ING Financial Markets.

The BoE has kept rates at 0.5 percent for more than 2-1/2 years — already its longest period of inaction since World War Two — and its stock of asset purchases unchanged since February 2010, when the economy was emerging from a deep recession.

But the momentum shifted over the summer from a bias to hike rates to more easing as stocks slumped and the euro crisis triggered fears of bank collapses and a renewed recession.

($1 = 0.648 British Pounds)

Additional reporting by Fiona Shaikh and Peter Griffiths; Editing by Mike Peacock

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