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It’s getting scary out there

So, interest rates are down to 0.5% and the Bank of England is given permission to begin “quantitative easing”. It is now considered nostalgic to look back to the balmy days of last summer and autumn (okay, so it rained most of the time) when interest rates were at 5% and we were all raising our eyebrows at the way Zimbabwe was printing money. Now the UK has decided to move into unknown territory. And, the scary thing is, no-one really knows what is going to happen as a result of this new policy but we mostly seem to accept that there is no alternative.

 

Yesterday, the Bank of England reduced interest rates for the sixth time since October, down to 0.5%. They will also start an asset purchase scheme to the tune of £75bn initially, although the Chancellor has given permission for this to rise to £150bn, which will be “financed by the issuance of central bank reserves” or “quantitative easing”. This is not exactly the printing of money but a situation where the Bank will be able to buy up government and corporate bonds in the market and so inject some liquidity into the financial system. The Bank reckons that it will take 3 months to complete their spending spree.

Interest rates down to 0.5%, quantitative easing introduced.

Interest rates down to 0.5%, quantitative easing introduced.

 

The Monetary Policy Committee (MPC) of the Bank of England concluded that a further easing of their monetary policy stance was warranted because of the weakening of world activity; persistent problems in international credit markets; a sharp drop in UK output; further fall in business investment; rapid run-down in stocks; rising unemployment and a substantial risk of undershooting the 2% CPI inflation target.

 

However, the MPC did note that a very low level of Bank Rate “could have counter-productive effects on the operation of some financial markets and on the lending capacity of the banking system.” Institutions need to keep a margin between their lending rates and their borrowing rates. Savers are not going to lend their money to banks offering an interest rate of 0.1% and a lower Bank Rate at this level may well have little effect on private sector lending. What it may do, however, is give more scope to the government to raise money by issuing government bonds which the public may see as a safer option, and so help to fund its deficit – isn’t that good news? Remember the government will probably have to find £140bn during the coming fiscal year to fund its deficit which will amount to 10% of GDP.

 

Also, the quantitative easing may only end up in allowing banks to hoard more liquidity as they desperately try to improve their balance sheets and they may still be reluctant to lend to consumers and industry alike.

 

One important result of all these changes is the effect on savers and pensioners. Those who have prudently saved over their lifetime and put their money into savings accounts, equities and bricks and mortar have seen their capital values plunge and their incomes decimated. By contrast, those who got us into this mess can retire on protected pensions and continue to live the good life.

 

Governments around the world are attacking this global financial problem with every policy measure they can lay their hands on. But is it too little, just enough or even overkill. It’s the story of the three bears but with no-one having any idea as to what is “just right”. Will the creation of more broad money fuel a future boom which will be followed by an even greater crash? Will countries be impoverished for a generation or more as governments raise taxes and borrowings to pay for their current fire-fighting efforts? The story continues.

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Posted in Bank of England, Banking, Inflation, Interest rates, Monetary Policy Committee, Public Finances

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