Quantitative Easing

Quantitative Easing started, in the UK, on Wednesday 11th March 2009. This is now known as QE day. Depending on your viewpoint, the exercise could be inspired, foolhardy or a waste of time.

The aim of Quantitative Easing is to inject cash into circulation so that banks will start lending in order to stimulate economy activity.

However, there are many risks involved with Quantitative Easing. It is untried in the UK. No-one can say that it will work as intended. It could stoke up inflation.

It's the first time the policy has been tried in the UK and some are calling it the last throw of the dice to save the country from an even deeper recession.

The first downside to Quantitative Easing occurred in the weeks between announcing that Quantitative Easing would take place and QE day. Quantitative Easing involves the Bank of England spending up to £150bn on public-sector and corporate debt. The public-sector debt is traded as gilts (British government bonds) which pay a fixed rate of interest based on their issue price for a fixed period of time. Gilts are traditionally split into three classes; short, medium and long term. Short term gilts have a maturity date within 7 years. Medium term gilts have a maturity date from 7 to 15 years. Long term gilts have a maturity date greater than 15 years. The market or tradable price of medium and long term gilts was seen to rise between 17% and 20% just before QE day. The effect of a rise in the price of gilts is a reduction in the effective yield. So, the yields of medium and long term gilts reduced by around 16%. This has an adverse impact on those buying an annuity as the annuity rate are based on gilt yields. So it is expected that annuity rates will drop by around 16% during March 2009.

Quantitative Easing is like printing money. In the 1980s the printing of money in the UK lead to high inflation. Quantitative Easing may be more targeted but whether or not it leads to high inflation, like printing money in the 1980s, only time will tell. If we are lucky, the Bank of England will start to raise interest rates and sell the gilts and the corporate bonds, they bought during Quantitative Easing, at the right time to stop inflation getting out of control. If we are unlucky, inflation will take off in an uncontrollable manner. The Bank of England will then have to take draconian measures to bring down inflation which could result in high unemployment, home repossessions and pensioners unable to meet their basic living costs.

Quantitative Easing has angered some. Ros Altmann, an independent policy adviser, explains that the plan to get the institutions selling gilts to invest the money in UK company debt instead, "is not going to happen!" He goes on to say

"Institutions will switch to overseas debt or top quality bonds, but will not put much into smaller companies who desperately need the funds.

"Whoever is advising the government on this simply does not understand how institutional investors operate."

For further information about that start of Quantitative Easing in the UK see on the BBC website.