The Bank of England has gone all in. By cutting interest rates to 0.1% and announcing a fresh £200bn of money creation via its quantitative easing programme it has fired all the conventional weapons in its arsenal.
There will be some who say this is all reminiscent of the Beyond the Fringe sketch where Peter Cook demands “a futile gesture” to raise the whole tone of the war. Others will saythe Bank’s new governor Andrew Bailey had no choice given the state of the markets and the imminent lockdown in London. Bailey has had a good first week in the job.
The “futile gesture” argument would carry more weight if the Bank had merely cut the cost of borrowing. To be sure, 0.1% is the lowest official interest rates have been since the Bank was founded in 1694 but trimming them from 0.25% is not going to do much to stem the inevitable flood of business failures and job losses caused by the Covid-19 pandemic.
Instead, the real meat was the increase in the QE programme, which came sooner and was a lot bigger than the City had been expecting.
Back in January, the then governor of the Bank of England Mark Carney said he thought there was the capacity for the markets to absorb a further £120bn of asset purchases under the QE scheme and that this would be the equivalent of a one percentage point cut in interest rates.
Things have moved on since then, and the extra borrowing that the government has embarked on to fight Covid-19 – £32bn and counting – means there is scope for the Bank to do more QE. Using Carney’s rule of thumb, the Bank has just provided a stimulus equivalent to almost two percentage points off interest rates.
The Bank’s actions need to be seen in the context of recent developments in the financial markets – the fall in the value of the pound to its lowest level since the mid-1980s and a rise in gilt yields, the interest rates paid to those holding government bonds.
The reason for both trends has been the strength of the US dollar – the safe haven of choice when markets are in a state of utter panic. By signalling it is prepared to buy gilts through its QE programme, the Bank is hoping to make them more attractive and so reduce yields.
Markets were impressed by the size of the QE announcement, which is the equivalent of about 9% of UK GDP. By comparison, the ECB’s €750bn progamme announced late on Wednesday night amounts to just over 7% of eurozone GDP. It is a sign of how fast things are moving that the Fed’s QE expansion, which was 3.3% of US GDP, now looks puny.
This was the second emergency move from the Bank in just over a week. Its monetary policy committee could have waited until its scheduled meeting next week but decided there was no point in delay.
The initial response in the gilts and currency markets was positive but not wildly so. That suggests the Bank might need to do more in the coming weeks. Bailey, like all central bankers, is extremely nervous about “helicopter drops” of money – which is where the Bank prints money for the Treasury to spend. But he has not ruled them out.
