Last week’s Monetary Policy Committee decision to cut the Bank of England base rate to 0.5% was overshadowed by a £75 billion cash injection into the British economy.
The latter move heralds the start of the Bank’s quantitative easing policy. Money will be used to buy assets such as gilts and corporate bonds to increase money supply and ultimately improve the loan-deposit ratio in the banking system, facilitating lending.
Although Mervyn King, the governor of the central bank, suggested in a speech to the Confederation of British Industry in January that unconventional methods could be used to stimulate the economy, he stressed that “we are not there yet”.
On February 17, however, he wrote to the Chancellor asking to bring in the measures.
Despite being forewarned, the market appears to have been taken aback by the scale of the announcement, which allows for up to £150 billion to be spent.
“I guess the difficulty for the market is assessing what impact this is going to have,” says Keith Wade, the chief economist at Schroders. “The only relatively recent example they have is Japan and it didn’t work so well there.”
Wade says he expected a figure of about £20 billion, so the size of the asset purchase scheme was a pleasant surprise
“The risk here is that the money comes in and just sits in the banks and doesn’t get lent out,” he says. “One thing that has happened, however, is that the gilt market is flying as [the package] was much bigger than expected.”
The focus will be on the banks to see if the measures are effective in restarting frozen credit markets.