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Bank of England stands by the presses as prospect of more QE grows

Economists widely expect another £50bn in quantitative easing when the Bank announces its latest policy decision on Thursday

The Bank of England is widely expected to set the printing presses in motion again this week by announcing billions more in its quantitative easing programme.

But with unemployment stubbornly high, businesses bemoaning the fact that they face barriers to obtaining loans and economic growth looking shaky, voices are growing louder suggesting policymakers should find better ways of directing the cash.

Economists widely expect another £50bn from the Bank when it announces its latest policy decision at noon on Thursday. That would take its quantitative easing programme to a total of £325bn.

It was a scheme launched in 2009 against the backdrop of markets reeling from the collapse of Lehman Brothers and rates already almost as low as they could go. The Bank argued that inflation was on course to undershoot the government-set target of 2% and so the Bank would start creating money to buy up assets, primarily British government bonds, known as gilts. Sir Mervyn King, the Bank’s governor, pledged the money would “percolate” through the economy.

Fast-forward three years and inflation is well above target while credit conditions for most businesses remain tight, despite the Bank’s big liquidity injections.

Many economists stand by the view that QE was the best response to a bad situation. Others say the billions of QE that may be still to come would be better spent elsewhere than in the gilt market.

For David Kern, chief economist at the British Chambers of Commerce (BCC) the problem is that those smaller companies that drive job creation in the UK are not getting help to grow and unemployment is likely to stay high until they do.

He concedes the situation would have been much worse without any QE but says there have been shortfalls nonetheless. “The main area in which QE did not have its full effect is on lending, particularly on bank lending to small and medium-sized enterprises (SMEs),” he said.

Kern added that he would have liked to see the Bank buying assets beyond gilts, something discussed at the start of the programme in 2009 but barely realised. In his eyes, QE could have been used to buy bonds from commercial banks that are made up of their bank loans to businesses, also known as securitised lending.

The lobby group said the onus was on chancellor George Osborne to supplement QE with his long-promised “credit easing”.

Referring to proposals for a bank dedicated to lending to smaller businesses, Kern said: “Looking forward and being practical what we need now is to implement an effective credit easing programme as early as possible and if that doesn’t work, create an SME bank.”

In its own research the Bank argues that QE has a significant positive effect on the economy, boosting output and keeping inflation closer to target than it would otherwise have been.

There are many in financial markets who back the Bank on this.

History should judge the Bank of England and its QE policy favourably,” said Alan Clarke, economist at Scotiabank. “At the height of the worst credit crunch and recession in living memory, the BoE did pretty much everything in its power to prevent a more pronounced contraction. It is possible that inflation ends up being higher than it might otherwise have been, but that is a small price worth paying.”

The Bank has also noted in working papers a significant reduction in bond yields from QE. That is something that does get passed on beyond financial markets, said George Buckley, chief UK economist at Deutsche Bank in London.

For larger businesses that issue bonds the impact will have been a direct reduction in interest rates, given that they usually borrow at a spread over government bonds. For smaller businesses the impact may be less direct. But to the extent that banks sell some of their gilt holdings to the BoE they can lend more to small businesses,” he said.

Economists are divided over how much more QE is on the horizon, especially following tentative signs last week that economic activity is picking up. But if there is more to come this month and again later in the year, economists at Fathom Consulting have radical suggestions for how to use the money. They say QE is targeting the wrong problems and that the return on the programme has been “weak at best, and at worst it may have caused actual harm”.

Fathom argues instead for changes that would direct any fresh electronic cash at what it sees as the source of the UK’s economic crisis: an overvalued UK housing market.

Its solution involves QE being used to kickstart wider investor interest in new bonds backed by troubled assets. Fathom wants the Treasury to set up a “bad bank” through which the government can purchase troubled mortgage-backed assets that are weighing down commercial banks’ balance sheets, at an appropriate discount. This “bad bank” should then be allowed to issue a bond backed by these troubled assets, which the BoE should buy via another round of QE.

Danny Gabay, director at Fathom Consulting, believes that would restore the UK to a path of growth by finally tackling deep-seated debt problems born of the credit boom that preceded the financial crisis. “The solution to this massive debt overhang which encompasses both public and household balance sheets is categorically not more debt,” he said.

The MPC itself is by no means unanimous in feeling more gilts purchases are the only way to plough on with QE. For policymaker Adam Posen, who, like Kern, favours a bank dedicated to small business lending, QE needs to go beyond government assets.

He has been urging the government to ramp up pressure on banks to lend, demanding new rules for banks rather than just credit easing promises as made last autumn. As for what the BoE can do, Posen has signalled his support for more QE on Thursday, but also advocated the BoE buying assets other than government bonds as part of the programme.

As Posen and his colleagues weigh up the pros and cons of more QE, they will be comforted by the fact that the latest round of criticism is nothing new and by no means restricted to the UK.

Economists at the National Institute of Economic and Social Research (NIESR) recently trawled through research into the effects of QE programmes, including in Japan last decade. They conclude that few studies have been able to “confidently identify” evidence of an effect on the availability of bank credit. In other words: “The transmission to the real economy may be less effective than suggested.”

As they note, such scepticism is longstanding.

In an open letter to President Franklin Roosevelt in 1933, John Maynard Keynes likened policies that aimed to raise output and income by increasing the supply of money in circulation as “like trying to get fat by buying a larger belt”. © 2012 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds