At the end of today's meeting of the Bank of England's Monetary Policy Committee (MPC) the headline decision was that it decided against any further quantitative easing (QE) at least for the time being. The MPC has already sanctioned some £200bn of QE in a move designed to stimulate growth in the UK economy. Under this policy the Bank has injected money into the economy through the purchase of various financial assets including government bonds. The aim has been to substantially boost the lending on offer by the commercial banks. This move will be welcomed by the MPC's hawkish members including the chief economist (Spencer Dale) who opposed the November expansion in QE. It was less of a surprise to see that the MPC also kept interest rates on hold at a record low 0.5% for the 11th consecutive month.
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MPC's decision to suspend (stop) further quantitative easing (Election Year anybody?) has resulted in a contortion of the gilt market, and has raised inflation. This is because using open market reserves, the Central Bank has been able to increase the money supply to banks without having to issue or create new money and that has created a situation where money value has come out of nothing.
By creating this extra amount of credit for banks, the idea was that they will stimulate spending by increasing the amount of loans banks issue in the economy.The reasoning has seemed to backfire a little bit. From the BoE (bank Of England) quartelry report (4Quarter, 2009) there have been indications that future lending will be increased, but at the time, there has been no drastic increase in lending by banks. The BoE will eventually have to increase the interest rates o combat the inflation.
In terms of interest rates, the Central Bank Of England will have to do one of two things:
1) Increase interest rates - borrowing is brought back under control by combination of higher interest and (probably more importantly) by debt deflation OR
2)interest rates are kept low as they are currently - result borrowing grows, inflation rises gently but the debt-fuelled bubble just gets bigger.
Added with the latest employment data that was published yesterday, we might very well see, dare i say it... stagflation (textbook case, doubt we see it if interest rates are increased and maintained)?
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