Guest Post: UK Embarks on Quantitative Easing

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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…

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  1. AlanM

    Cheers Lune. Good job of putting the issue in context both wide/deep/long/large (10% of GDP) and immediate (gilt yield move in one day unprecedented). Very much in the spirit of NC, classic example of why I visit often.

  2. Peripheral Visionary

    Is it my imagination, or is the intention of government to repay the only difference between “quantitative easing” and printing money to pay government debt?

  3. Anonymous

    Maybe I’m stupid, but I can’t see how QE will work in the long run, when tks to haveing to bail out the banks, UK debt issuance must explode.

    Surely this is a circular situation, which goes nowhere.

    B E buys old Gilts with printed money, the 150 billion from one window…..but is selling new Gilts just as fast, or faster, from another window.

    All this exercise does is reduce in the short term Gilt rates, but if they are selling far more than they are buying, which they are, then rates will back up.

    Also why the mkt should want to dump it’s gilts before an avalanche of new issuance should worry the mkt far more. Because either the mkt wants out of gilts, you can have all my old ones at 3 %….or it knows that future rates will be much higher and a better buy, I now want 5 % to buy yr crap.

    Either case says QE is gonna fail.

  4. Anonymous

    UK QE is aimed at pushing down the long end of the yield curve which should in theory push down the yield curve for corporate debt, making it cheaper for all those highly leveraged in debt businesses to roll over their debt. I believe that the UK is aiming to buy the equivalent of 25 percent of all 5-25 year gilts whilst still issuing shorter term debt. Foreign central banks tend to buy gilts with a maturity of less than 5 years so to prevent them selling and causing sterling to tank these will not be purchased. Notice that they will not be buying index linked gilts and many investors will be selling their gilts for index linked ones or inflation protected ones.

    At the minute it seems to have had little impact on short term corporate debt, sterling as drifted down and a switch to index linked gilts has been clear. Time will tell whether it works, but it would appear to be setting up some perverse incentives for certain types of trade which could well come back to haunt the decision makers. I guess they needed to do something since companies are shredding their expenditure on non essential items evidence of which can be seen in the order book for the fork lift truck manufacturer close to where I live which has dropped close to 70%.

  5. UrbanDigs

    Our fed HAS started first round of QE via purchases of Agency MBS! I think they are up to $150Bln or so with 500Bln being target for now.

    Here is actual Q & A on fed website:

    How will purchases under the agency MBS program be financed?

    Purchases will be financed through the creation of additional bank reserves.

    That electronic creation of additional bank reserves, is pure money printing created out of thin air to purchase actual assets from primary dealers!

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