Last updated: February 4, 2010 8:14 pm

Gilt markets unruffled as QE suspended

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Britain’s government bond markets remained an oasis of calm on Thursday even as the Bank of England suspended its programme of creating money to purchase assets.

The quantitative easing initiative, launched last March, was unprecedented in the Bank’s 300-year history, and aimed to boost the stock of money and spending in the economy.

There had been fears that the Bank’s decision to keep interest rates at 0.5 per cent and hold the creation of money at £200bn would put upward pressure on gilt yields because the biggest purchaser in the market was leaving the table.

But investors had expected the Bank’s well-signalled move and did not indicate concern at the government’s ability to finance debt in the future. Ten-year government bond yields fell on Thursday, having briefly spiked higher after the noon announcement.

Economists on Thursday continued to argue over whether QE has worked. The Bank’s monetary policy committee said the £200bn of assets purchased would “continue to impart a substantial monetary stimulus to the economy for some time to come”, but it could point to few concrete examples of its effectiveness.

Peter Westaway of Nomura said: “I think it had a big effect on confidence when it was introduced.” But Danny Gabay of Fathom Consulting argued: “We find little compelling evidence to suggest that the Bank’s quantitative easing programme has made a material difference.”

No one is really sure. The big problem is that we cannot know what would have happened if the Bank had taken no action last March.

Some circumstantial evidence exists on the efficacy of QE, but it is far from perfect. The economy edged edged out of recession in the fourth quarter of last year and cash spending rose by 1.1 per cent in the third quarter. Both go some way towards fulfilling the Bank’s aim of halting the slide into depression and underpinning recovery.

But attributing the recovery to QE is problematic, since many other forces have also contributed to the slightly improved outlook, including the natural tendency of economies to grow, the fiscal stimulus, lower energy prices and rising global asset prices.

Some intermediary benchmarks for QE’s success have been disappointing. The annual growth of money held by households and non-financial companies has been falling ever since QE was started and was up only 1.1 per cent on a year earlier in December. The Bank said that less money might have been held without QE, but initially it hoped to boost this figure to the 7 to 8 per cent levels seen for most of this decade.

In the corporate bond market, the yields on securities eligible for purchase by the Bank fell relative to other securities after the policy was started, but this effect has waned over time.

In the government bond market, the announcement of QE and its subsequent extensions certainly reduced the cost of borrowing for government, but the effect was small compared with the cuts in interest rates seen in late 2008 and has diminished over time.

One mark of seeming success is that the corporate bond market appears to be increasingly liquid, with companies issuing larger quantities of new debt – effectively bypassing banks – than in previous years.

But with such meagre evidence for the efficacy of QE, many economists shrug and say at least it seems to have done no harm. Britain has not encountered Zimbabwe-style hyper-inflation and the economy appears to be recovering, at least for now.

The lack of conviction in such statements remains a problem. With politicians engaged in arguments over the appropriate pace at which to reduce the deficit, any meaningful debate requires an understanding of how well monetary policy can offset fiscal tightening. The Bank still cannot provide such assurances.

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