BoE injects another £50 billion into the economy
The Bank of England (BoE) today pumped more money into its quantitative easing programme as it left interest rates frozen at a record low of 0.5% for the fifth month running.
It has decided to extend the current scheme - which enables the Bank to create new money and use it to stimulate the economy by buying bonds - by £50 billion, taking it up over the £150 billion ceiling set by the Treasury. It now stands at a whopping £175 billion.
The Bank had faced a difficult choice as stopping the quantitative easing process too early could stall the economic recovery while ploughing too much cash poses an inflation risk for future years.
It started buying up corporate and government bonds back in March in the hope this would boost spending and bank lending. However, opinion is split as to how well quantitative easing is working.
The Bank says it will take at least nine months to gauge the effects of the scheme.
Howard Archer, chief UK and European economist for IHS Global Insight, says the MPC's latest decision shows it continues to have serious concerns about the long-term growth prospects of the UK economy.
"This is reinforced by the fact that the BoE had to seek permission from the Chancellor to extend the quantitative easing programme beyond £150 billion.
"Despite the recent improved data, the economy continues to face serious headwinds and sustainable recovery is still very far from certain. The Bank of England itself has long been concerned that economic activity could be hindered for some considerable time to come by the ongoing need for financial institutions, households and companies to adjust their balance sheets. Furthermore, bank lending to businesses remains very weak and spreads on bank loans are elevated, which is a serious threat to recovery prospects," he says.
Archer believes the BoE will use all of the extra £50 billion that it has requested. "Whether or not this proves to be the final amount will depend critically on whether the recent signs of economic recovery are sustained and whether or not bank lending picks up significantly," he says.
In April, the central bank’s Monetary Policy Committee ended six months of rate cuts, leaving the base rate an all-time low of just half a percentage point and it now has few options left open to it. It can't reduce the rate to a negative level, but is unlikely to increase it in the coming months either because of the continuing risk of inflation.
It is not clear how long the current low level is likely to last. Some economic indicators are showing encouraging signs, but others, including unemployment and the shrinking economy, are getting worse.
Archer says: "It is clear that interest rates are going to stay down at 0.50% for some considerable time to come, very probably deep into 2010."
The move to keep the base rate at its current low level is good news for mortgage borrowers with interest rates that track the BoE base rate, as it means they will not see their monthly repayments increase in June.
The historically-low base rate is, however, less positive for savers. Banks and building societies have passed on the cuts, with headline rates on fixed, instant access and cash ISA accounts falling dramatically since October.
While the Bank has decided to pump more money into the economy, recent economic data has suggested that the recovery is slowly gathering pace.
Surveys from Halifax, Nationwide and the Land Registry have all pointed to signs of life in the property market, while the service sector grew at its fastest pace for 17 months in July and industrial production unexpectedly rose 0.5% in June from May.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
Monetary Policy Committee
A committee designated by the Bank of England to regulate interest rates for the UK. The MPC attempts to keep the economy stable, and maintain the inflation target set by the government and aims to set rates with a view to keeping inflation at a certain level, and avoiding deflation. The MPC meets on the first Thursday of each month and discusses a variety of economics issues and constitutes nine members: the governor, the two deputy governors, the Bank’s chief economist, the executive director for markets and four external members appointed directly by the Chancellor.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.