Why quantitative easing could make a comeback

Could quantitative easing make a comeback in 2024? At first glance, this looks like a silly question. When quantitative easing (QE) was first introduced in the UK, it was 2009. Bank rate was just 0.5 per cent, and even 5.25 percentage points of interest rate cuts hadn’t managed to stimulate the economy. The Bank of England (BoE) embarked on a programme of asset purchases to boost activity and ensure that inflation could move – upwards – over the medium term. Today’s economic backdrop couldn’t be more different. 

One of QE’s biggest goals is to lower long-term interest rates, providing extra monetary policy stimulus to the economy. And the case for more of the same this year looks incredibly weak: the BoE expects inflation to remain above target at 3.1 per cent even at the end of 2024. What’s more, should the BoE need to boost the economy, it can turn to a far more conventional policy tool: with the policy rate at 5.25 per cent, there is plenty of scope for interest rate cuts. 

 Since 2009, we have also learnt a lot more about how QE works. The impact of asset purchases seems to depend on the wider macroeconomic backdrop, meaning not all episodes are created equal. Last year, Gerard Lyons, chief economic strategist at Netwealth, dubbed the UK’s rounds of QE “the good, the unnecessary and the bad”. He told the Treasury Committee that while QE had formed part of a ‘good’ policy response to the financial crisis, the most recent round compounded the inflationary impacts of supply shocks. According to Lyons, policymakers stuck with this ‘bad’ tranche of QE, “even though it was quite clear that it was not only not working but exacerbating the situation”. 

As the chart shows, the onset of the Covid-19 pandemic in 2020 triggered a huge package of QE. But this coincided with this phase of government spending, leading to accusations of ‘fiscal dominance’. After all, when a central bank buys bonds, it pushes down yields, making government borrowing cheaper. Given that the cost of new borrowing has soared (the 10-year gilt yield has risen from 0.3 per cent in March 2020 to 3.7 per cent today), could central banks face pressure to use QE to support the public finances in 2024?

The short answer is “not in an era of central bank independence”. The BoE itself stresses that there are multiple institutional safeguards to prevent government financing concerns having an impact on monetary policy. In 2020, government spending and asset purchases both soared, but the BoE maintains that this does not imply fiscal dominance: “Instead, this correlation is a natural byproduct of fiscal and monetary policy acting countercyclically and independently in response to a sharp deterioration in the outlook.”

This wasn’t the only time that the BoE was accused of fiscal dominance. After the bond market turmoil triggered by Liz Truss’s 'mini' Budget, the BoE had to make bond purchases to stabilise gilt markets after yields surged. Economists dismissed suggestions that the BoE was providing room for the government to continue with its (doomed) fiscal programme – arguing that the measures were firmly for the purposes of financial stability. If we do see more QE in the years ahead, it will probably be on these grounds. 

Dario Perkins, managing director of global macro at TS Lombard, thinks that “QE is now a policy that should be reserved to safeguard financial stability, not as a source of ongoing monetary stimulus”. After all, this is what we saw in the aftermath of Trussonomics, while the ECB has pledged to do something similar with its anti-fragmentation tool. Perkins thinks that rapid surges in long-term rates that threaten stability could be used to justify short-term asset purchases, something he refers to as ‘not QE’. According to Perkins: “While some periodic ‘not QE’ is possible, most central banks are now out of the QE game.”