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A world without QE

Created:

4 February 2010

Written by:

Jonathan Eley

As expected, the Bank of England's Monetary Policy Committee opted not to extend its asset purchase programme, better known as quantitative easing, at the conclusion of its monthly Monetary Policy Committee meeting. Experts are divided about what impact QE had, and what will happen now it has ended, if indeed it has.

The idea behind QE was to get the economy moving again by boosting the money supply. The Bank 'printed' money to purchase high-quality assets, mostly gilts, from commercial banks, with the idea being that banks would then re-lend that money to individuals and businesses.

That hasn't really happened to any great degree. As our economist Chris Dillow pointed out yesterday, bank deposits held by households and non-financial companies grew by just 2.6 per cent in 2009, despite nine months of bond-buying by the Bank. that compares to avarge growth of 7.3 per cent a year in the preceding 10 years. The only place in the money supply where QE is clearly visible is on the Bank's own balance sheet - its total assets have risen to £245bn. This limited economic impact might yet mean the Bank has to restart QE - its statement certainly left the door open to such a move.

A common accusation is that QE simply poured money into risk assets, stoking another price bubble in property, commodities and shares. Again, though, the reality is more complex. According to National Statistics, institutional investors, who call the shots on stock markets, were net sellers of UK equities over the summer, when prices were rising hard.

The big rallies in equities and other risk assets may be more a function of the return of risk appetite, and this is where QE might have had most impact. Monetary support on this scale reassured investors that governments and central banks simply would not allow the economy to collapse into depression - and they responded by buying the riskier assets that they'd dumped indiscriminately in the last quarter of 2008.

So if the main contribution of QE was merely the aversion of 'tail risk', its removal should in theory have little impact on asset markets. But investors have other things to worry about. Will there be a sovereign downgrade and a sterling crisis to go with it? Can UK companies meet their earnings expectations in 2010? And when will interest rates start going up? This last question is probably most important of all, since a year of 0.5 per cent base rates has arguably contributed as much as anything else to asset price rallies!

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