Will the Bank of England’s new round of QE boost the economy?

5th July 2012

The ECB is expected to cut its benchmark interest rate from 1% to 0.75%, a record low. It may also do something more radical: cut the deposit rate for commercial banks to 0%, thereby reducing the incentive for banks to leave cash with the ECB.

Having resisted cutting its key rate below 1 percent or joining its U.S. and British counterparts in pursuing quantitative easing, Bloomberg‘s Jana Randow and Gabi Thesing say that the ECB's giant leap in monetary policy may ultimately result in limited economic gain. Furthermore, it may fuel speculation about what the ECB can do after its conventional policy options are spent.

"It's a bold move and will lead the ECB into uncharted territory," said Julian Callow, chief European economist at Barclays Capital in London. "With soaring unemployment and few signs of the economy recovering, some strong monetary medicine is needed. But let's be honest, a rate cut by itself will not end the recession, we need much more for that."

Randow and Thesing go on to say that while ECB rate cuts might not stimulate aggregate demand, they would lower borrowing costs for troubled banks. They could also build on the confidence boost that eurozone leaders provided last week when they took steps toward a deeper political and banking union.

"A rate cut will have a very, very limited effect on inflation and activity," said Jens Sondergaard, senior European economist at Nomura International Plc in London, who nevertheless predicts the ECB will lower rates. "You may ask why bother in the first place, but it's wrong to dismiss rate cuts. They have an important signaling effect, and markets want reassurance that measures are being taken."

The Bank of England, on the other hand, is expected to extend quantitative easing (QE) by another £50 billion, raising its total of asset purchases to £375 billion.

The move comes after it was revealed that the Bank's monetary policy committee rejected more stimulus by the narrowest of margins: four in favour of more quantitative easing and five against at last month's policy meeting. So what triggered the move? According to The Guardian's Larry Elliot, it was the latest health check on the services sector from Cips/Markit, which showed that the Purchasing Managers' Index (PMI) for services fell to 51.3 in June from 53.3 in May, suggesting  that the sector grew at its weakest pace in eight months.

It remains to be seen whether these additional measures will be enough to bolster economic growth.

For instance, the Bank for International Settlements – the central bank of central banks – warned last month that excessive monetary easing by central banks could create "significant negative repercussions" for the major advanced economies. The BIS report emphasizes the view that international capital flows stirred up by monetary policy were a primary factor leading to the preceding crisis and that these flows would lead to the next one.

This is in stark contrast to the "global saving glut" hypothesis-which says that the funds pouring into the U.S. in the previous decade originated largely from the surplus of exports over imports in emerging market economies, writes John B. Taylor, a professor of economics at Stanford University, in an opinion piece in today's Wall Street Journal.

"The BIS should be taken seriously. It warned long in advance about the monetary excesses that led to the financial crisis of 2008."

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