Bank of England faces QE dilemma

Ian Campbell and Hugo Dixon

UK QE: The Bank of England faces a dilemma over quantitative easing. Andrew Sentance, one member of the monetary policy committee, has been criticised for suggesting the programme of printing new money to buy government bonds may be put on hold. That certainly won’t help the government sell gilts. But that’s hardly the BoE’s job. As for QE itself, it doesn’t seem to be working.

Sentance’s comments may have helped spark a rise in bond yields yesterday. The 10-year gilt is now brushing 4 percent again. But what else does the government expect? Its loose fiscal policy has led to an avalanche of bond issuance. The BoE should not be expected to bail it out. And any sign that the BOE was deliberately attempting to help the government fund itself would terrify investors and cause the pound to plummet and inflation to soar.

The BoE’s remit has to be to keep inflation low, while avoiding deflation. By this yardstick, the decision over whether to continue with QE is more complex. Despite the BoE’s programme – the original £125 billion operation is now almost finished - funds don’t seem to be getting out from the banks into the economy. The flow of net lending to UK businesses remained negative in May, according to the central bank. In that month, net bank lending to businesses declined by £3.4 billion, following a £6 billion drop in April. The annual growth rate in lending to businesses in May has plummeted to 0.1 percent.

For mortgages, the picture is also bleak. The BoE reported net mortgage lending was the lowest since its series began in April 1993 – a time when house prices were 60 percent below the current level. Unless mortgage lenders start doling out more, further house price falls are all but certain.

Monetary data, too, confirm the curiously sharp decline in credit since quantitative easing began. For the past three months, the broad M4 measure of money in the economy has expanded at a negligible annualised rate of 0.8 percent.

Meanwhile, the latest GDP figures show that the economy continued to shrink in the second quarter - by a worse than expected 0.8 percent. So there aren't yet decisive signs of green shoots.

But this doesn’t mean the BoE should keep spraying more money around, particularly since it isn’t obviously effective. The authorities should realise they don’t possess a magic wand – and the best that can be expected is for the UK to grind its way slowly back to health.

Context News
UK GDP fell by 0.8 percent in the second quarter to June, twice as much as expected, taking the annual decline to 5.6 percent according to the Office for National Statistics.

The GDP figures were published the day after Andrew Sentance, an external member of the Bank of England’s monetary policy committee, said the BoE was considering whether to put on hold its quantitative easing programme designed to pump money into the economy.

His “1984” portrays one kind of nightmare; for him, the prospect of reviewing a million books might well be another.

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