But, while it should continue to keep bond yields down, it’s no panacea. It may even prove counter-productive by again squeezing real disposable income through higher cost-led inflation, rather than boosting activity. It’s true that QE1 from March 2009 into 2010 loosened conditions further at a time when nominal policy rates were already close to zero.
QE adjusted, Bank rate is about minus 2.25%.
Real rates are really red
Bank of England simulations suggest this initial £200bn of QE alone was the equivalent of slicing an extra 150bp off Bank rate. Extrapolating from this, the total £375bn of QE from March 2009 to November 2012 is akin to slicing a cumulative 280bp off Bank rate to minus 2.25% (or about minus 5% in real terms)!
Our analysis shows how accommodative monetary policy will have to stay in 2013 just to avoid a re-widening of the output gap. Combining this with the Bank’s estimate, 2013 would require extra QE of about £30bn (giving a cumulative £ 405bn) just to avoid tightening 2012’s overall policy position. Given the £1.1trn of conventional gilts outstanding, this would take the BoE’s share from around a third to nearer 40%.
And, hypothetically, if the economy lapsed into a protracted recession (risk case), at least £450bn extra QE would be needed (to a cumulative £825bn) to return to the extreme policy looseness of 2009 and 2011. In which case, the Bank would then account for three quarters of conventional gilt holdings.
In practice, the BoE will probably settle somewhere in the middle. But, by avoiding ‘QT’ (sales of gilts back into the market) the UK will be deferring correction of what’s been an unmatched long-term loosening that easily pre-dates the crisis. No major country has net loosened its overall policy stance more than the UK and US.
And it’s no coincidence, given the subsequent inflation risk, that countries with the loosest policies generally suffer the softest currencies. This suggests the pound will be vulnerable once its safe-haven lustre from the eurozone fades.
GDP uneven through the year
The Bank’s base case has been for quarterly GDP to ‘zigzag’ through Q2’s Diamond Jubilee holidays’ production-loss, then Q3’s bounce-back helped by the Olympics and Paralympics. So, given these distortions, it won’t be until the November inflation report that the Bank will next have a full view of what’s happened.
But the portents are not good, with June’s record rainfall offering an even softer first leg of the zigzag than the MPC anticipated. While lower oil prices and widespread price discounting for clothes and food have nudged RPI and CPI inflation rates to two-and-a-half-year lows, sales volumes are undershooting retailers’ expectations.
Admittedly, Q2’s 0.7% quarter-on-quarter GDP plunge – the third fall in a row – provides a springboard to growth from the Olympics. But, this should be temporary and a reason for extending QE further at the November MPC meeting.
Before then, the Bank would be warranted in its August inflation report to bring forward its May projection of sub-2% CPI by Q3 2013. Our own simulations suggest that CPI inflation could just shave 2% in spring 2013, though rising thereafter on base-effect and the pipeline costs that bloat inflation but cap discretionary spending.
Either way, the economy is not firing. But, with the inflation outlook appearing more benign in the short term, BoE Governor Mervyn King may just be able to boast of a return to the CPI target at his scheduled leaving drinks in June 2013.