In line with the market’s expectations, the Bank of England today cut interest rates by a further 50 basis points to a new record low of 0.5% and simultaneously announced it will inject an additional £75 billion of money into the system in an attempt to kick-start commercial banks’ lending to the private sector.
The new measures agreed on by the Bank’s Monetary Policy Committee (MPC) and sanctioned by the Treasury are known as quantitative easing—steps taken by central banks once the normal methods of boosting the economy have been exhausted.
The idea behind having interest rates close to zero and employing quantitative easing is that with very little benefit to commercial banks of holding money (minimal interest to be gained) and with more money floating around in the system, the nation’s banks will be encouraged to lend again. In turn, as borrowing becomes more readily available, households and businesses that have been dealing with a credit drought will be more willing to take advantage of banks’ new offers. At least, that’s the reaction the Bank of England is hoping for.
But the problem is that households just aren’t spending at the moment: we are a nation of hoarders at present and who could blame us? The current high levels of uncertainty are enough to put anyone off unnecessarily delving into their pockets. The seventy-five-billion-pound-question is will the new measures be enough?
Being an unprecedented move by the Bank, quantitative easing will have to run by trial and error regarding what sort of assets to purchase and how much of each to trigger new lending and borrowing.
Rather than actually printing new money, the Bank is instead buying financial assets such as government securities (gilts) and corporate bonds, paid for by increasing its own reserves held on deposit and thereby in turn injecting new money into the system. In purchasing corporate bonds, the cost of borrowing for businesses should also decline, in addition to borrowing being more available.
It is a highly contentious issue and numerous commentators have recently chastised the Government for resorting to a method that has not been proven to work, but endless interest rates cuts have been having very little impact and the Bank had few other options to hand.
Economist analysts at Charles Stanley sounded relatively optimistic immediately following the Bank’s announcement: “Given the reconstruction already undertaken in the banking sector regarding recapitalisation, the ring-fencing of toxic assets and the insuring of other debt, [the interest rate cut] combined with quantitative easing should give the UK an excellent chance of overcoming the credit crunch.”
The UK isn’t the first nation to trial run quantitative easing. It was employed by Japan between 2001 and 2006 but in the face of little evidence as to its effectiveness, economists have suggested that Japan’s measures were not widespread or severe enough to have the desired effect. Similarly, the US Federal Reserve’s various moves to boost credit flow by expanding its balance sheet of late can also be seen as quantitative easing, although the long-term impact here remains to be seen.
London equity markets fell further into the red following the Bank's announcement as traders digested the implications of the new approach. The FTSE 100 index was over 2% lower at 3,568 at last check, while the FTSE 250 index—generally considered a more accurate measure of the British economy—slipped 1% to 6,023.
