We are now well into the Bank’s programme of quantitative easing. They have announced they will buy up to £125,000,000,000 of government bonds, with a few corporate bonds as part of the programme. The Bank’s own balance sheet, around £40,000,000,000 when the Rock crisis struck, was last seen at £215,000,000,000.
The Bank’s last report on inflation admitted it was still above target, but commented that given the large amounts of spare capacity in the economy and the downward pressure on wages and salaries, they expect it to go below target later this year. They did, however, go on to say:
“There is considerable economic stimulus stemming from the easing in monetary and fiscal policy, at home and abroad, the substantial depreciation in sterling, past falls in commodity prices and actions by authorities internationally”
There indeed is. The government hoped that the low interest rates and printing of money would push up government bond prices and make raising the borrowing easier. Instead, there has been an uneasy truce in the government bond market, with some worrying already about what will happen to prices once the stimulus is withdrawn. If the Bank started to sell the bonds it has bought in at the same time as the government is trying to sell more than £200,000,000,000 a year of debt, there could be a lot of indigestion in the market. In such conditions interest rates may be forced up.
It appears that a lot of the money being injected on both sides of the Atlantic is flowing more readily into shares and into commodities. That helps build a bit of confidence. It also helps raise the substantial sums some companies need to obtain from shareholders to repair their own damaged balance sheets. It is also inflationary, as oil moves from $35 to $60 a barrel.
UK inflation is still high owing to the large devaluation of the pound last year. We are still feeling the delayed affects of that, as businesses have to re-order from overseas at higher prices in sterling. It also gives UK businesses a bit mroe pricing power than they would otherwise enjoy in these weak markets. In the last few weeks the pound has performed better. Whilst there is no evidence that the UK authorities are trying to get the value of sterling up to dilute the inflationary effects, it probably reflects other major jurisdictions keen to see their own currencies lower for once. In this recession gripped world, many would like a cheaper currency to make exporting easier.
This is the easy part of quantitative easing. For a bit it creates a better mood without undue inflation. Then comes the difficult part. When do they have to stop it, before it does unleash uncontrollable inflation? How can they stop the easing without causing falls in asset prices and halting a recovery in activity? They need an exit strategy.
There are hints that they plan to hold the government bonds they buy for longer, not turning from buyer to seller, in an attempt to reduce the impact of their shift on the price of bonds. The government, however, still needs to sell bonds to cover the costs of repayment as they fall due. The impact may come down to how long a time gap there is between stopping buying up bonds, and when the big repayments arise. I expect the aim will be to delay the adjustment for at least another year. When QE stops on both sides of the Atlantic it will have an impact on markets generally. Asset prices today are higher than two months ago thanks to QE.