06 Aug 2009, Alastair Marsh, Risk magazine
The bank said that, while improvements were visible in credit conditions, market confidence and banks’ funding conditions, the recession in the UK “appears to have been deeper than previously thought”.
To make things worse, the bank also faces difficulty in achieving its 2% inflation target – June inflation fell to 1.8% from 2.2% in May. The slow trickle of government stimulus to the real economy, the past depreciation of sterling, and the need for banks to repair their balance sheets is likely to restrict the availability of credit, while falls in asset prices and high levels of debt may dampen spending, it said.
“While some recovery in output growth is in prospect, the margin of spare capacity [the difference between potential output and actual output] in the economy is likely to continue to grow for some while yet, bearing down on inflation in the medium term,” the bank said.
Therefore, “to keep inflation on track to meet the 2% inflation target over the medium term, the programme of asset purchases should be increased to a total of £175 billion,” bank governor Mervyn King announced.
The bank will extend the asset purchase facility to include all conventional gilts with a minimum residual maturity of more than three years. Also, the bank will add an extra auction every week. Auctions will be conducted on Tuesdays (for gilts with a maturity greater than 25 years), in addition to those already held on Mondays (10–25 years) and Wednesdays (three to 10 years).
Together with the UK Debt Management Office (DMO), the bank will also make a significant amount of the gilts purchased at auction available for on-lending to the market through the DMO’s repo market activity.
UK government bond yields fell on news of the expansion of quantitative easing. The yield on the 30-year gilt fell to 4.37% at 3.35pm BST today from 4.51% at close yesterday, while the yield on the 10-year gilt slid to 3.71% from 3.83%. Five-year yields fell to 2.92% from 3%.
The expansion of the programme will take three months to complete the bank said, adding that the scale of the programme would be kept under review.
Quantitative easing began on March 5, when the bank announced it would begin a programme of asset purchases worth £75 billion, financed by the issuance of central bank reserves, for monetary policy purposes. The reserves would also finance the purchase of medium- and long-term gilts in the secondary market, in effect boosting the supply of money in the system to meet the inflation target. On July 30, the Bank of England announced its intention to buy asset-backed commercial paper from struggling UK companies, starting on Monday August 3.
The bank also announced today that it will maintain its bank rate at 0.5%. The European Central Bank made a similar announcement, maintaining a bank rate of 1%.