Bloomberg News

BOE Restarts QE as Euro Crisis Threatens to Prolong Slump

July 05, 2012

ECB Cuts Benchmark Rate to Record Low of 0.75%, Deposit to Zero

A relief depicting two lions holding keys is seen on a door at the Bank of England in London. Photographer: Chris Ratcliffe/Bloomberg

The Bank of England restarted bond purchases two months after halting its expansion of stimulus as the deteriorating outlook spurred policy makers to ramp up efforts to kick start a recovery.

The Monetary Policy Committee led by Governor Mervyn King raised its asset-purchase target by 50 billion pounds ($78 billion) to 375 billion pounds and said the purchases will take four months to complete. Separately, the European Central Bank cut its key interest rate below 1 percent for the first time and China lowered benchmark rates for the second time in a month.

The Bank of England’s resumption of quantitative easing is a part of a twin-pronged effort that includes a new credit- boosting program by the central bank to pull Britain out of a recession. With inflation easing and reports this week showing that factory, services and construction activity weakened in June, policy makers were spurred to act by continued concerns about the threat from the euro-area debt crisis.

“It’s a good decision and they need to do it because the recovery is taking so long,” said George Buckley, an economist at Deutsche Bank AG in London. “This is as much a decision to offset the future downside risks from the euro area as it is to try and support the rather flagging recovery.”

U.K. 10-year government bonds pared their advance after the announcement. Ten-year gilt yields were down 2 basis points at 1.7 percent as of 2:13 p.m., after falling as much as five basis points before the decision. The pound traded at $1.5520, down 0.4 percent on the day.

Rate Cuts

The ECB cut its main rate to 0.75 percent from 1 percent and its overnight deposit rate to zero. The People’s Bank of China said its one-year lending rate will fall by 31 basis points and the one-year deposit rate will drop by 25 basis points effective tomorrow.

Some “downside risks to the euro-area economic outlook have materialized,” ECB President Mario Draghi said at a press conference in Frankfurt. ‘‘Economic growth in the euro area continues to remain weak.’’

Explaining its decision, the Bank of England said it expects inflation will continue to ease and that without more stimulus, it was ‘‘more likely than not’’ to undershoot the 2 percent target in the medium term. The economy has contracted for the past two quarters and indicators ‘‘point to a continuation of that weakness in the near term, both at home and abroad,’’ it said.

‘‘In spite of the progress made at the latest European Council, concerns remain about the indebtedness and competitiveness of several euro-area economies, and that is weighing on confidence here,’’ the central bank said.

BOE Survey

Thirty one of 41 economists in a Bloomberg News survey correctly forecast the Bank of England’s expansion. Two forecast no change, one forecast a 25 billion-pound increase and seven predicted an addition of 75 billion pounds.

Policy makers also left their benchmark rate at a record low of 0.5 percent today. The central bank will publish the minutes of today’s meeting on July 18.

Vicky Redwood, an economist at Capital Economics Ltd. in London, said today’s QE expansion is unlikely to be the last and forecast another loosening in November.

‘‘We think that the MPC will give the economy even more support in the coming months in order to get the recovery back on track and prevent a significant undershoot of the inflation target,” she said in an e-mailed note.

While inflation has held above the central bank’s 2 percent target since December 2009, it slowed to the weakest in 2 1/2 years in May. The central bank forecast in May that consumer price growth will ease to about 1.6 percent in two years.

Bank Funding

Reports this week showed U.K. manufacturing and building output dropped in June and services expanded at the slowest pace in eight months as the government’s fiscal squeeze and the euro- area debt crisis hampered demand. King said on June 26 that the global economic outlook has deteriorated since the central bank published forecasts on May 16.

In addition to weighing on export demand and confidence, the euro crisis is pushing up banks’ funding costs and curtailing lending. The Bank of England’s response includes a program to boost credit to companies and households and a sterling liquidity facility for banks.

European leaders took a step toward resolving the turmoil last week, easing the terms on loans to Spanish banks and paving the way for cash-strapped lenders to tap their bailout fund directly.

Still, the impact of the euro crisis is being compounded by signs of slowing growth in the U.S. and in Asia. The International Monetary Fund cut its 2012 and 2013 U.S. growth forecasts this week and said the world’s largest economy remains “subject to elevated downside risks.”

To contact the reporter on this story: Scott Hamilton in London at shamilton8@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net


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