naked capitalism

Submitted by Lune

On March 5th, the Bank of England announced that for the first time in its >300 year history, it will begin quantitative easing to lower interest rates and increase the UK’s money supply.

Details from The Telegraph:

The Bank’s Monetary Policy Committee voted to cut interest rates by half a percentage point to a new historic low of 0.5pc, and said it would immediately pump £75bn of cash into the economy.

The sweeping move – known as quantitative easing and considered to be the “nuclear option” for central banks – was expected, but the speed and scale of the initial investment came as a surprise.

…

In a letter to the Bank’s governor Mervyn King, published today, the Chancellor authorised the MPC’s request to spend a total of £150bn on government debt and private sector assets.

The Bank said the majority of the new money will be spent on government debt, or gilts, with a maximum of £50bn spent on private sector assets to increase the flow of credit available to businesses.

For Americans (and Zimbabweans) who now view any monetary figure with less than 12 zeros behind it with a jaundiced eye, £150bn is indeed a large sum. Per The Telegraph:

The sheer scale of the operation is illustrated by the fact that the entire corporate bond and commercial paper market in the UK is worth only £57.5bn, while the amount of gilt-edged government debt eligible for the Bank’s auctions totals £250bn.

It also represents ~10% of the UK’s GDP.

In one welcome sign, yields on gilts (British government bonds) have dropped significantly since the announcement:

With investors piling into gilts in anticipation of the auctions, the first of which is next Wednesday, gilt prices jumped by the biggest amount for at least 17 years, with some declaring it the most dramatic day in UK government debt in history. A rise in gilt prices pushes yields lower.

“For gilt yields to move by 30 basis points in a month is a big move,” said Philip Shaw, of Investec. “For it to move that much in a day must be pretty much unprecedented.”

The 10-year benchmark gilt yield dropped by 32 basis points to 3.32pc.

This will hopefully lead to lower interest rates for private borrowers.

While the BoE is probably doing the right thing, it is troubling that the UK’s economic conditions have become so dire that the “nuclear option” of last resort becomes the only choice available.

As Bloomberg reports:

The pound fell to its weakest in more than five weeks against the euro after Britain’s housing sales slipped to the lowest level since at least 1978 and manufacturing shrank the most in four decades.

…

Factory production dropped 2.9 percent in January from December, the Office for National Statistics in London said. Economists in a Bloomberg survey predicted a 1.4 percent decline. Manufacturing shrank 6.4 percent in the three months through January, the most since records began in 1968.

…

Gross domestic product contracted 1.5 percent in the fourth quarter, the most since 1980, a report on Feb. 25 showed.

It remains to be seen whether the BoE’s actions will have the intended effects or whether the large potential downsides to QE overwhelm any benefits to be had. At any rate, it will be instructive for American policy makers to watch the UK’s experiment with QE before possibly embarking on the same path in the near future. Of course whether they actually internalize any lessons to be learned from this opportunity is a different matter…