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Is It The End Of The Road For Quantitative Easing?

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In early August, in response to fears of a slowdown or a possible mild technical recession in the UK because of Brexit, the Bank of England cut interest rates from 0.5%, where they had been for seven years, to 0.25%. In addition, the bank announced an extra £70bn of Quantitative Easing (QE). £60bn of this will be government bond purchases and £10bn will be investment grade sterling denominated corporate bonds. This will have a knock on beneficial effect into the sub-investment grade corporate bond market and indeed into anything else that provides anything remotely considered to be a half decent yield. The bank is clearly pulling out all the stops to try to get the economy moving, or at least stave off a recession. Furthermore, Mr Carney, announced a £100bn Term Funding Scheme to banks, which they must pass onto borrowers at the new 0.25% rate.

The sterling devaluation of around 10% and the rise in oil prices over the last six months mean that inflation will rise over the next 12 months from virtually nothing to something more like 2%, albeit perhaps only temporary. These days this is seen as a “good thing” as it brings inflation back to something like normality. It also means that “real” interest rates, which are normally positive, will be even more negative than they have been of late. Real interest rates are actual interest rates minus inflation.

Unless we move into negative nominal interest rates and bond yields like most of the Eurozone, it would appear that the effectiveness of monetary policy here is approaching its end and some fiscal stimulus is taking over. The new Chancellor, Mr Hammond, is abandoning the idea of a balanced budget by 2020, indicating an end to the so called austerity regime of the previous Chancellor. Due to extremely low government bond yields (0.6% over 10 years and only 1.3% over 30 years) the government can borrow very cheaply to fund mega infrastructure projects such as HS2, and a new airport/runway, somewhere, anywhere! However, judging by the deliberations on Hinckley C, we shouldn’t hold our breath waiting for these projects to actually get underway. 

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