Opinions divided on further easing

Quantitative easing (QE) has had a positive impact on the British economy, many City experts say. But they have also warned the Bank of England against embarking on a second round, even before the Bank announced last week that it would pump no more money into the system in the immediate future.

“The economy would have experienced a very severe recession without QE, which has allowed it to adjust much more slowly than would otherwise have been the case,” says Moz Afzal, the chief investment officer at EFG Asset Management.

Gary Reynolds, the chief investment officer at Cour­tiers, also says QE in Britain has been beneficial. “It probably prevented negative monetary growth and deflation, and we certainly don’t know how bad the situation would have been without it.”

“We certainly don’t know how bad the situation would have been without it”

However, in both Britain and America, which em­barked on QE2 worth $600 billion (£375 billion) last week, the policy has had the greatest impact on spreads in the short to intermediate parts of the curve, which have “been artificially massaged to be as low as possible”, according to Afzal.

He points out that spreads in America are showing “unprecedented steepness at the longer part of the curve – 30-year gilts and ­treasuries – which shows that the market is predicting a build-up of inflationary pressure. Looking back at the data since 1981, spreads between 30-year and 10-year treassuries are at record highs. It is a similar story in the UK, where the spread between 30-year and 10-year gilts is at 110bp [basis points], the steepest spread for many years.”

According to Afzal, this implies that another round of QE is not only unnecessary but could be harmful in igniting inflationary pressures in Britain. (article continues below)

“A second round of QE would certainly prove beneficial for financial asset prices, but the risk that both the USA and the UK could pump too much money is increasing, given what is happening to spreads at the long end of the curve.”

Reynolds agrees that QE2 could prove harmful and do “untold damage” to some sectors, sending property prices soaring. “We already have inflation in the system,” he says, referring to the fact that the consumer prices index in Britain is already persistently above target.

In addition to the inflation numbers, higher than expected third-quarter GDP growth of 0.8%, as well as upbeat manufacturing data, had already weakened the case for further QE, which currently amounts to £200 billion.

However, not all experts agree with Reynolds and Afzal. In a paper published last week Fathom Consulting urged the Treasury and the Bank of England to use QE2 to ­create a new “bad bank”, which would buy troubled mortgages from lenders. This would “unblock” the credit supply, the economic and market consultancy said.

Fathom compared Brit­ain’s situation to that of Japan in 1997, pointing out that much as “zombie companies” had hobbled Japan in the wake of its own financial crisis, so “zombie households” – kept alive simply by Britain’s UK’s economic recovery now.

But Reynolds says there is no comparison between Britain and Japan, and that “the Bank of England will clearly introduce QE2 if that proves necessary, but it should allow market forces to continue to do their job and increase the money supply if it looks like declining, and allow the economy to do the rest”.

John Anderson, the head of credit at Gartmore, also questions the need for a further round of QE, although he has some sympathy with the idea of zombie households in Britain. “If interest rates go up to 2%, they will have effectively quad­rupled, and you have to wonder how many households will cope,” he says.

In general, however, Anderson is concerned about the “moral hazard” implications of Fathom’s recommendations.

“We’ve already bought RBS and other institutions, so I cannot see why we should set up yet another establishment to solve what is really a private sector problem.”

Anderson says that the supply of credit in Britain is not a problem, and he is optimistic about the British economy’s prospects, “seeing no sign at all of a double-dip recession”.