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Bank of England launches QE3 onto a still-stormy sea

A new £50bn round of quantitative easing suggests the Bank remains concerned about the economic climate

The Bank of England is feeling more relaxed about the state of the economy. But only a bit. That’s the message from the decision to embark on QE3 – a third wave of the money creation programme made possible by the purchase of UK government bonds.

Threadneedle Street has taken notice of recent surveys that have painted a “more positive picture” and the rally in asset prices since the turn of the year. Yet the nine-strong monetary policy committee (MPC) clearly thinks the better news will not last. It expressed three key concerns in the statement that announced the £50bn boost to the money supply over the next three months.

The first cause of worry remains Europe, despite signs that the tortuous negotiations that will allow Greece to get its €130bn bailout are at last staggering to a conclusion. The chances not just of a Greek default but a complete departure from the single currency have risen in recent weeks. The rest of the eurozone is becoming exasperated by the failure of Athens to deliver on its austerity pledges; Greece’s capacity to cope with further growth-harming policies has been exhausted. At the moment, the hope is that a firewall can be put between Greece and the rest of the eurozone, but the Bank of England is worried that there may be collateral damage that will affect the UK.

Anxiety number two is the tightness of domestic credit conditions, in part due to the ripple effect from Europe but in the main caused by banks in the UK reducing their leverage in an attempt to build up capital. For many small and medium-sized companies, securing adequate working capital remains a problem.

Finally, the MPC knows that the economy has yet to feel the full effects of the government’s deficit-reduction programme. As the Institute for Fiscal Studies noted week, only 6% of the planned cuts in current public spending have yet been made.

The Bank’s decision, while not a surprise, is not without its risks. Inflation remains more than double the government’s 2% inflation target, and while Threadneedle Street has sought to quantify the impact of QE, it does not – and cannot – know for sure what the inflationary implications of such a big monetary boost will be. The expectation is that inflation will fall like a stone this year, the result of a bombed-out economy and no repetition of last year’s rise in commodity prices. As things stand, that looks a reasonable call.

Perhaps a more immediate concern is that QE is not really getting to the parts of the economy that need it, and, in its third incarnation, is subject to the law of diminishing returns. The fact that output is still 4% below its pre-recession peak is an indication that QE has proved to be a blunt instrument.

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