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The economy is either getting better or getting worse

In my blog yesterday I listed some of the positive signs that the economy was showing in terms of house prices, house building and the service sector. Then later in the day the Monetary Policy Committee (MPC) announced that the UK recession “appears to have been deeper than previously thought.”

 

Not only that, but the MPC thought it necessary to take further action to try to correct the economy’s problems. The committee surprised the markets by announcing that they were to embark on a further round of “quantitative easing” which is akin to printing money and pumping it into the economy. The chancellor had previously agreed in March to allow the Bank of England to pump £150bn into the economy, of which they have used £125bn to date. Now they are to use the remaining £25bn plus a further £25bn to inject another £50bn of funds into our “fragile” economy.

 

The Governor of the Bank, Mervyn King, wrote in his letter to the chancellor that: “The future evolution of output and inflation will be determined by the balance of two sets of forces. On the one hand, there is a considerable stimulus still working through from the easing in monetary and fiscal policy and the past depreciation of sterling. On the other hand, the need for banks to continue repairing their balance sheets is likely to restrict the availability of credit, and past falls in asset prices and high levels of debt may weigh on spending.”

The Bank of England is pumping another £50bn into the economy

The Bank of England is pumping another £50bn into the economy

 

The Bank will spend this money on the purchase of gilts in the market over the next three months. The British Chambers of Commerce urged the MPC to purchase more company debt rather than government debt. However, one of the effects of purchasing existing government bonds is to push their price up and their yield down. Falling yields make them less attractive to investors and this has helped to revive interest in both equity markets – which have been rising strongly – and the market for corporate bonds. This means that larger companies at least have been finding it easier to raise funds through the markets rather than relying on the banks which are conservatively trying to rebuild their balance sheets.

 

In fact, earlier this week Dealogic said that £88bn had been raised by companies in the City through new equity and convertible bonds so far this year, which compares favourably with the £118bn raised in the whole of last year. The Bank of England announced a couple of days ago that the money supply during the second quarter was growing at the slowest rate for a decade, although lending rose by 2.7% in the second quarter, up from 1.9% in the previous quarter. So, even though lending is still reasonably tight, the fact that larger firms seem able to raise money in the equity and bond markets, should mean that smaller firms will get a greater share of the limited bank lending which is still available.

 

Is the Bank of England doing the right thing? If they are looking at the CPI target, then at 1.8% last month it is already below its 2% target and expected to fall further this year. Given the increasing rate of unemployment and the size of the output gap coupled with low increases in earnings, it would look as if the economy could well absorb the increased monetary injection. At the moment the economy appears to be making something of a recovery and the MPC is obviously worried that if further support is not forthcoming, we will experience a “double dip” whereby GDP growth worsens again later in the year. Given that economic observers are equally worried about whether future inflation or deflation is a possibility, it is probably best for the MPC to stimulate the economy now.

 

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Posted in Bank of England, Consumer Price Index, economic growth, Inflation, Monetary Policy Committee, Money Supply

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