The Bank of England might need to take a leap of faith on an untested credit plan to do what quantitative easing is failing to achieve.
With both of its deputy governors questioning the effectiveness of asset purchases, and economists forecasting a halt to that stimulus, that leaves the so-called Funding for Lending Scheme as officials’ primary policy tool. Policy makers begin a two-day meeting on Nov. 7 to decide on QE’s future.
“We are in unchartered territory,” said Steven Bell, chief economist at hedge fund GLC Ltd. in London and a former U.K. Treasury official. “The search for alternatives to QE is gathering pace” and with the FLS, the central bank is “trying new ways as the economy fails to respond to the medicine.”
The Bank of England’s three-month-old plan encourages banks to provide cheap credit to companies and households, which contrasts with the trickle-down effect of gilt purchases through QE. A rethink by policy makers will reach a climax this week as they assess new forecasts and the impact of a program that’s left them with almost a third of the gilt market.
The nine-member Monetary Policy Committee will probably leave the target for asset purchases at 375 billion pounds ($602 billion) on Nov. 8, according to 35 of 45 economists in a Bloomberg News survey. Six forecast a 50 billion-pound increase, and four anticipate a 25 billion-pound expansion.
Officials’ disenchantment with QE has become increasingly apparent, with minutes of their October meeting showing that some members questioned the impact future gilt purchases could have. The central bank said last week it had completed the final tranche of its latest 50 billion-pound round of bond-buying.
In a speech last week, Bank of England Deputy Governor Charlie Bean said consumers’ and businesses’ concerns about the outlook may undermine the impact of QE. In September, Deputy Governor Paul Tucker said the asset-purchase program no longer has “the same bite.”
Royal Bank of Scotland Group Plc and JPMorgan Chase & Co. are among banks that have abandoned forecasts for more QE this week, citing comments by policy makers. Even with bond purchases falling out of favor, the economy may still need support. BOE Chief Economist Spencer Dale said the 1 percent surge in third- quarter gross domestic product might not be sustained and there could be a “sharp fall back.”
Goldman Sachs Group Inc. said in a Nov. 2 note that its conviction that the MPC will expand QE this week is “relatively low.” It changed its forecast for more stimulus on Nov. 8 to 25 billion pounds from 50 billion pounds.
“While we continue to see the need for more easing, it looks increasingly likely that any further action will take the form of additional ‘credit easing’ rather than QE,” Goldman economists including Kevin Daly in London said.
Governor Mervyn King introduced the FLS in June as a “coordinated action” between the central bank and the Treasury to fight the “black cloud of uncertainty” related to the euro- area crisis that has stifled Britain’s economy.
The program, which began on Aug. 1 and could boost credit by at least 80 billion pounds, allows banks to borrow treasury bills from the central bank to fund lending into the economy. Lenders will have 18 months to use the facility and then up to four years to repay. The central bank said last month that 30 financial institutions had signed up to the FLS, including Lloyds Banking Group Plc and Barclays Plc.
“The FLS has always been a substitute, not a complement” to stimulus, said Richard Barwell, an economist at RBS in London and a former central bank official. “You’re asking QE to do too much. The Bank of England is more than just about monetary policy now.”
Former MPC member Charles Goodhart said in an interview on Nov. 2 that the central bank should expand its toolkit to aid the economy. Business Secretary Vince Cable has described the FLS as “the best conceived” initiative currently in existence to stimulate the economy, though he noted it would take a “few months” before its effects would be visible.
“Although quantitative easing was originally successful, it’s now largely a spent force,” Goodhart said. “The problem is that it’s not answering the correct problem, and the correct problem is nothing to do with a shortage of liquidity.”
Concerns about mounting inflation pressures may also lead the MPC to stay its hand on QE this week. The central bank said last month that consumer-price growth was likely to remain above its 2 percent target in the near term. While inflation cooled to 2.2 percent in September, the least in almost three years, cost increases by some of Britain’s biggest power companies may add to price pressures in the coming months.
Policy maker Martin Weale said last month that he’s concerned about whether pumping more money into the economy is the right thing to do with inflation above the target.
“It is certainly not self-evident to me in the light of the apparent stickiness of inflation that substantial extra support for the economy would be compatible with the inflation target,” Weale said in an interview with the Daily Mail.
“You do sense the internal discussions that they have on QE are concluding that either enough has been done, or to do more risks increasing financial imbalances,” said Neil Mackinnon, global macro strategist at VTB Capital and a former U.K. Treasury official. “The bank is having a rethink of where they go from here. The FLS is in part a response to some of those concerns.”
Risks to Britain’s economic recovery still persist, with an index of services falling to its weakest level in almost two years in October. The gauge dropped to 50.6 from 52.2 in September, Markit Economics said today, below even the lowest estimate in a survey of 30 economists by Bloomberg.
The pound extended its decline against the dollar after the report. It was at $1.5978 as of 10:40 a.m. in London, down 0.3 percent on the day.
In contrast, China’s services industries rebounded from the slowest expansion in at least 19 months, adding to manufacturing gains that indicate the world’s second-biggest economy is recovering from a seven-quarter slowdown.
The purchasing managers’ index rose to 55.5 in October from 53.7 the previous month, the National Bureau of Statistics and China Federation of Logistics and Purchasing said. A separate services index released today by HSBC Holdings Plc and Markit Economics in Beijing fell to 53.5 in October from 54.3.
Elsewhere in the Asia-Pacific region, Indonesia’s economic growth held above 6 percent for an eighth quarter as domestic consumption and rising investment countered an export slump. Meanwhile, Australia said retail sales rose 0.5 percent in September from August, compared with the previous month’s pace of 0.3 percent.
In the U.S., service industries probably kept growing in October, lifted by gains in consumer spending that are helping bolster the expansion, economists said before a report today. The Institute for Supply Management’s non-manufacturing index was at 54.5 last month, little changed from 55.1 in September, according to the median forecast in a Bloomberg survey before tomorrow’s figures.
The ISM’s services report will be the last piece of economic data before the Nov. 6 election, when voters decide between giving President Barack Obama another four years and changing course with Republican challenger Mitt Romney.
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