King to create money to revive UK demand
By Chris Giles in London
Published: February 11 2009 11:41 | Last updated: February 11 2009 19:54
The Bank of England on Wednesday pledged to use its powers to create money and buy up assets in the UK economy, becoming the latest of the world’s central banks to try to revive demand by unorthodox measures.
Mervyn King, the Bank’s governor, said further interest rate cuts might be needed as he published an extremely downbeat quarterly inflation forecast.
He acknowledged that, with official interest rates already at 1 per cent, further cuts would not make much of a difference.
The Bank’s interest rate setting committee would instead pursue a policy of “quantitative easing” – the creation of cash to buy government bonds and private sector assets – to bring down interest rates paid by companies and consumers.
Mr King said future measures were “likely to include actions aimed at increasing the supply of money in order to stimulate nominal spending”.
His comments sent the pound tumbling against the dollar. On a trade-weighted basis, sterling fell 1.5 per cent, closing more than 3 cents lower against the US dollar at $1.4352. UK government bond yields also fell.
Similar to printing bank notes, quantitative easing electronically raises the amount of money in the economy in an attempt to encourage spending.
The Bank hopes people who gain the new cash in their bank accounts will spend it and that commercial banks, which will find their levels of deposits rising, will use the new funding to increase their lending. Quantitative easing could reduce interest rates on longer-term government bonds and the cost of corporate borrowing.
The Bank’s central forecast suggested the UK economy would contract by 2.9 per cent in 2009 to rebound strongly in 2010.
Mr King said he hoped recent policy action, including a 4 percentage point cut in interest rates since October and a fiscal boost representing 1 per cent of UK national income, would help to boost the economy.
He said that action, combined with falling oil prices, the biggest decline in sterling for a generation and an end to inventory drawdowns, should lead to a recovery in annual output growth in 2010.
But the governor was far from confident about the chance of a rapid recovery, saying the “balance of risks ... is very much to the downside”. The Financial Times’s best estimate of the Bank’s risk-adjusted forecast suggests it thinks that it as likely as not that the UK economy will contract 3.7 per cent in 2009, with anaemic growth in 2010.
“The length and depth of the recession will depend to a significant extent on developments in the rest of the world, where a severe economic downturn has taken hold,” Mr King said. He wanted the monetary policy committee to be able to start quantitative easing by March 5.
Corporate and government bond prices rose sharply on expectations of large purchases from the Bank. The yield on 10-year UK government bonds fell by about a quarter of a percentage point, reversing in one day about half the increase in the yield since the start of the year.
Simon Hayes of Barclays Capital said: “The message could not have been clearer: quantitative easing has arrived.”
“Now that the QE cat is out of the bag there is no obvious reason for the MPC to hang around, squandering time with modest rate cuts and procrastinating QE,” Mr Hayes said. He forecasted the Bank would cut interest rates to close to zero next month and begin a large programme of asset purchases.
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