After yesterday’s announcement from the Bank of England after its regular monthly meeting that it was suspending asset purchases via its Quantitative Easing (QE) programme one might reasonably assume that this was the last word on such a policy for the day. After all any similar policy should be announced then one might think. However it has turned out that this is not true. Later in the day it transpired that the Chancellor of the Exchequer has authorised the Treasury/Bank of England to continue with a similar policy. This policy had been announced back on the 19th January 2009 which was the same day as QE. However as the Bank of England had taken centre stage since then this secondary policy had been somewhat back stage and ignored. Both programmes were authorised by the Chancellor on the 3rd March 2009.
This was explained in a letter from the Chancellor of the Exchequer Alistair Darling to the Chairman of the Treasury Select Committee John McFall. This can be found on http://www.hm-treasury.gov.uk/d/chx_letter_040210.pdf
What does it mean?
This letter authorises the Bank of England to spend up to £50 billion on asset purchases. However these will now be private sector assets as opposed to the public sector ones that the Bank of England’s QE programme mostly ended up purchasing. It will buy commercial paper,corporate bonds and secured commercial bonds. It will be financed by the issue of Treasury Bills. So just to make it clear whilst the Bank of England will no longer buy government bonds it will continue to buy corporate bonds.
Differences from previous policy
1. It will be paid for by the issue of Treasury Bills and not the Bank of England creating money.
2. It will purchase private sector assets as described above.
Implications of such a policy
Actually on a first reading this policy looks preferable to the Quantitative Easing policy which had previously been pursued. This is more in line with the way the US Federal Reserve has operated and as I wrote yesterday it has had more success than we have had with unconventional monetary operations so far. So hopefully companies will find it easier and cheaper to finance long-term borrowings. This does seem to have been the American experience. Also borrowing the money and not simply creating it is a better more transparent system as I never liked the idea of circulating money between the Bank of England and the Treasury.We should have done more of this and less of QE. If we had our economy would be in better shape now.For the curious the average rate paid on 3 month Treasury Bills in January was 0.49% according to the Bank of England.
The only drawback is that some of these private-sector markets are quite small in the UK so it may take a while to spend the money and have an impact. So far the Bank of England has only spent some £479 million on Commercial Paper and £1,484 million on Corporate Bonds. It bought £2.11 million yesterday so at that rate it would take quite some time to spend £50 billion!
Why was this not announced at 12.00pm yesterday?
I am sure there will be plenty of speculation about why this was released on the HM Treasury website in the evening and not with the Bank of England’s announcement. It certainly is not good policy procedure in my view and smacks of political opportunism and possible disagreements between the Chancellor and the Treasury. However it on first reading looks a better policy that QE even if it may prove harder to spend. I will leave analysing possible rows and disputes to the political press.
One last thought. There was not much left of the concept of Bank of England independence and this puts another nail in its coffin.
Having had time to think a little more about this policy it still looks a good idea to me. One flaw that does come to mind is the adage for banks ” be careful of borrowing short and loaning long”. In principle this can apply to nations too and in borrowing on a rolling 3 month timescale and loaning to bonds which have much longer lifespans e.g 5 years,10 years this is exactly what we are doing.
Implications of The Pain in Spain for the UK
There is a clear implication of the problems in Spain (please see my article on Spain and her problems on the 2nd February) leading possibly to the UK. I have already written about the risks of contagion from government debt markets, although remember that we do have the option of a currency devaluation. This is a route we have taken in the past with 1967 and 1992 coming immediately to mind and these have not always been optional!
However I am thinking more of the banking system. When we went into crisis it appeared that the Spanish banking system had operated under a superior regulatory regime when compared with ours and was accordingly in better health. So from an apparent position of strength Santander (a Spanish bank) was able to buy Abbey, Alliance and Leicester and some of Bradford and Bingley making it a major player in UK banking. It published what on the face of them were solid figures this week. But with the severe problems in its domestic economy I cannot help but have the feeling that there must be underlying strains there. The unemployment rate in Spain and the housing crisis must be hurting the Spanish banking sector. Yesterday the market felt this too as Santander’s share price fell by 9.95%. I understand that the Madrid stock exchange was lower by 2.5% this morning.According to the FT it is the second most widely held share in the UK.
Now I do not want to ratchet up fears at a nervous time and am aware that not only are we in such a time but I am also typing near to important US jobs figures. Also Santander has a prudent reputation. However if the distress in Spain rises and it does hit problems then there are clear implications for the UK. Should we have allowed it to expand so much in the UK? I had the feeling at the time that as the only buyer in our crisis we were letting Santander over expand in the UK.