7th June 2012
The question is prescient as the Bank of England comes under renewed pressure to resume its stimulus programme. It announced today that it will not extend the QE programme however. Initially, pressure emerged from the IMF – "Policies to bolster demand before low growth becomes entrenched are needed," said managing director Christine Lagarde.
Simon Ward at Henderson suggests that the MPC is leaning towards further quantitative easing: "The "MPC-ometer" forecasts an easing of policy at this week's Monetary Policy Committee meeting – its output is consistent with either a quarter-point cut in the Bank rate to 0.25% or a £75 billion expansion of gilt purchases." The MPC-ometer is a statistical model designed to predict Bank of England actions.
Not everyone is so sure: "The consensus among economists is for the monetary policy committee (MPC) to vote against any extension to the existing £325 billion quantitative easing programme. However, sharply falling inflation, a stagnant UK economy and growing threats from the eurozone mean that inaction by the Bank is not a certainty."
The markets are up around 4% on the week in expectation of further stimulus measures. It has been one of the key determinants of equity market rallies since the credit crisis. As such, any end to the QE programme looks difficult from an equity market point of view. Some are even predicting it will lead to a crash.
But it is not just the reaction of equity markets that needs to concern policymakers, there are far thornier implications for the bond market. The Bank of England has to wind down its holdings of government debt, but how does it do this without reversing the liquidity it has worked so hard to create and/or creating a significant spike-up in yields?
This piece highlights the difficulties of exiting a QE strategy: "Both the UK and US are heavily indebted and the removal of QE has further cheapened sovereign bonds. This is an argument against reversing QE. At the same time, the economy is recovering and central bankers want to avoid what Mervyn King, the governor of the Bank of England, has called "sowing the seeds of the next crisis" by keeping interest rates artificially low." Note that this was written in 2010. The difference now is that the economy has not recovered and interest rates are still at all time lows, making the problem of an exit even more pressing.
There is also an inflation issue. Quantitative easing may not have achieved the economic stimulus policymakers would have liked, but it has kept inflationary expectations high. As the Intrinsic Value blog points out:
"The problem for the US economy is that it needed inflation expectations to ward off the risk of deflation. However the current exogenous shocks such as commodity price volatility and the risk of inflation import from the emerging markets is chance that inflation could overshoot to the upside."
The Bank of England has, as yet, given little detail on how it would exit its quantitative easing programme. However, US policymakers have been more forthcoming: "Bernanke said the normalisation process will begin by ceasing the reinvestment of principal payments on securities, which would allow the Fed's balance sheet to contract. Subsequent steps would include the initiation of temporary reserve-draining operations and, when conditions warrant, increases in the federal funds rate target," he added.