QE3 - Will the Bank of England strike again?

With the very fragile economy continuing to show signs of further weakness and the eurozone debt crisis continuing unabated, the Bank of England’s Monetary Policy Committee (MPC) very nearly voted in favour of adding an additional £50billion of Quantitative Easing (QE) to the already committed £325 billion. The minutes of their June meeting showed that 4 members voted in favour of this (with one member voting for a smaller £25billion), which is only one short of the majority
needed to approve the action.

Their prognosis was that the risks to the UK economy had risen since their last month’s meeting, particularly from the Eurozone. The minutes stated: “The likelihood of a disorderly outcome looked to have increased, and that could, if it crystalised, have a significant effect on global demand and the stability of the banking system, including in the United Kingdom.”

QE is a method of electronically ‘printing money’ which is a technical device used to boost the money supply and, hopefully, drive economic activity. The Bank of England buys UK Gilts and other categories of assets with this ‘new’ money. This increase in the money supply has several effects, namely to reduce the value of currency (sterling), increase the value of the assets purchased and lower long-term interest rates, thus encouraging additional borrowing and investment.

It is therefore incumbent on the banks to lend these additional funds to businesses in need of working capital, but this has not always proved to be the case.

A counterpoint to these effects is that many economists believe the QE process leads to an increase in inflationary pressure. However, with the UK inflation rate dropping to 2.8% (its lowest level for 30 months) in May the Bank of England may be minded to go ahead with additional QE.

The minutes endorsed this possibility by stating: “On balance, most members judged that some further economic stimulus was either warranted immediately or would probably become warranted in order to meet the inflation target.”

We shall have to wait and see for their further deliberations.