Bank of England to buy £75bn in bonds

THE BANK of England has pledged to go on a £75 billion bond-buying shopping spree in an attempt to get the recession-hit economy growing again.

The plan emerged yesterday as the bank cut interest rates to new record lows. The bank’s governor, Mervyn King, said the rate cut to 0.5 per cent, the sixth in as many months, would probably be the last and it was now switching to injecting money directly into the economy by buying assets, mostly gilts.

British government bonds soared on the news that the bank would start “quantitative easing” – effectively printing money – on such an aggressive scale over the next three months; £75 billion equates to around 5 per cent of GDP.

Doubts remain over whether it will work but the bank may have felt it had no choice – the British economy shrank at its fastest in nearly three decades at the end of 2008, house prices are sinking at record rates and hundreds of thousands of jobs have disappeared.

“The world economy has turned down very rapidly since last autumn, the amount of money is not growing at all and the economy is in a recession, so we need to increase the supply of money,” Mr King said.

The government set the bank an initial overall limit of £150 billion for new money it can create, but £50 billion of this is money that had been previously earmarked for the Asset Purchase Facility, but will now be unfunded.

Quantitative easing has previously only been tried in Japan in the early part of the decade with limited success.

However, it has now become a watchword for central banks everywhere as interest rates near zero in the most serious world downturn for decades.

Many say the scale of the downturn caught the bank off guard, but it has acted swiftly since October when US investment bank Lehman Brothers collapsed.

Interest rates have fallen by 4.5 percentage points to their current all-time low of 0.5 per cent since then and are only stopping there probably due to worries that very low rates could have a counter-productive effect by hitting bank profits.

“The scale and timing of the quantitative easing operations appears significant,” said Ross Walker, UK economist at RBS.

“The lasting benefits for credit availability and demand are much more uncertain but, given the severity of the macroeconomic and financial backdrop, it is worth a try.”

The June gilt future settled 255 ticks higher on the day and yields on 10-year gilts fell 34 basis points, their steepest one-day fall in more than a decade, traders said. Sterling extended losses against the dollar, hitting a session low of $1.404.

The bank said it would buy medium and long-dated gilts and kick off the process with £2 billion on March 11th, targeting a variety of maturities so to not distort demand.

Gilt issuance is already at a record £146.4 billion this year and could balloon further in the next financial year as the public finances are in really bad shape.

The bank said even with the latest rate cut, there was a substantial risk of inflation undershooting the 2 per cent target in the medium-term.

“It is blatantly clear that the UK economy needs as much help as it can get, given that it remains mired in deep recession,” said Howard Archer, UK economist at Global Insight. – (Reuters)