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Is it time for QE2?

Later today the Monetary Policy Committee will announce whether it has decided to change the base rate or indeed increase its £200bn quantitative easing programme. So, is it time for QE2?

On the other side of the Atlantic many economists have been calling for a government stimulus to kick-start the US economy.

Fidelity asset allocation director Trevor Greetham thinks a fiscal stimulus is necessary. He says headline inflation rates are falling again and core inflation rates have been dropping for over a year, which coupled with the ample spare capacity means inflation rates very low in developed economies and more stimulus will be needed to avoid 2011 deflation.

He says: “In relation to global growth, massive stimulus in 2008/09 triggered a powerful v-shaped recovery but lead indicators are falling and the pace of recovery will moderate as the inventory cycle turns downwards.

“At this stage of the cycle, central banks would normally begin to cut interest rates to stimulate the economy, yield curves would shift downwards and become steeper and profits would become sluggish. However, with very little scope for interest rate cuts, I’d expect further quantitative easing before the end of this year.”

With very little scope for interest rate cuts, I’d expect further quantitative easing before the end of this year.

Trevor Greetham

But Capital Economics senior UK economist Vicky Redwood says QE2 would not be a silver bullet: “How much good extra QE does will ultimately depend on how bold the MPC is prepared to be – not only in terms of the amount of QE but what form it takes,” she says. “So far, the Bank has focused almost exclusively on buying gilts but given that it already holds a quarter of outstanding gilts, it might now be open to the idea of buying a wider range of assets, including more corporate bonds.

“And if, as is more likely, the MPC is fairly timid in its renewed attempts to boost the economy, the chances of a strong economy are even slimmer.”

Citibank analyst Michael Saunders says QE2 is unlikely. He says the MPC has indicated that it is generally confident of meeting the inflation target over the medium term, and even if those assumtpions were to be proven wrong, the Committee has scope to kick-start the UK economy without extra easing.

Money is as money does and the bloated monetary base ain’t doing anything

Paul McCulley

He says: “The MPC can provide extra reserves and liquidity to banks and non-bank institutions via open market-type operations which could expand the monetary base. It could also buy assets, either Government bonds or private sector assets to improve financial conditions or it could even pre-commit to a long period of ultra-low rates in order to lower market rate expectations.”

Pimco managing director Paul McCulley says the longer central banks continue to hope for revival off the back of the initial easing schemes, the less likely it becomes that a second round of easing will be the lone anitdote to economic malaise.

He says: “Money is as money does and the bloated monetary base ain’t doing anything, because the economy is in a liquidity trap of private sector delevering. QE2, if she is going to sail, should sail with a meaningful fiscal expansion on board – central banks can’t turn deflationary milk into a reflationary milkshake by itself. It needs the fiscal authority to show up with a proactive blender, sweetened with bigger-deficit sugar.”

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  1. QE2 could be very inflationary in the medium term so I hope they resist the temptation.

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