Recovery could be false dawn, warns Bank of England
Top policymakers at the Bank of England have warned that while a "virtuous" recovery is now possible, concerns remain about a potential false dawn.
The central bank's Monetary Policy Committee (MPC) - which sets the interest rate each month - voted unanimously to hold the base rate at 0.5% in September and keep its programme to create new money at £175 billion.
However, the minutes from the meeting show the MPC noted the near-term downside risks to economic activity had "lessened" during the month. It said "there was a possibility that the recovery in asset prices and confidence could mark the start of a virtuous upward spiral for the economy".
However, it appears the MPC remains wary against potential "false dawns".
"The banking system still had to complete a process of balance sheet adjustment, including raising new capital, and bank lending remained weak. The drag on aggregate demand growth from the financial sector was likely to be long-lasting," the minutes state.
Three policymakers - governor Mervyn King, David Miles and Timothy Besley - argued in favour of increasing the new money programme (known as quantitative easing) to £200 billion in August. Instead it was raised by £50 billion to £175 billion.
In September, however, both King and Miles said that while they thought an increase could be justified, they did not feel there was much point in changing the current course of the scheme until November.
There was no mention of whether the Bank of England may cut the interest rate it pays on commercial banks' deposits in an attempt to try and get them to inject more liquidity into the financial system, as flagged by King in a Treasury Select Committee meeting last week.
Howard Archer, chief UK and European economist at IHS Global Insight, says that while it remains possible for the Bank of England to adopt this policy, the absence of any comment on it in the minutes means it is unlikely to happen in the immediate future.
"The minutes suggest that the MPC was very much in 'wait and see' mode at its September meeting, having only just raised the quantitative easing programme by a further £50 billion to £175 billion in August," he adds
But Archer believes the MPC still appears open to further extending quantitative easing if bank lending fails to pick up or the recovery shows signs of faltering.
High levels of public debt internationally, and the persistence of a global imbalance, remained "downside risks" to the sustainability of the recovering, according to the MPC.
"The minutes of September's MPC meeting note the recent improvements in the economic and financial data, but still leave the door open to further policy loosening," says Vicky Redwood, UK economist at Capital Economics.
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.
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.