Published on 21 Sep 2011

Plan BoE, not Plan B

Forget this whole debate about £5bn more in capital spending. Even if it’s true, and even the person I suspect is the source of this story was himself suggesting the figure was “toppish”, £5bn is marginal. It is the difference between public sector net investment being cut from £50bn last year to £29bn by 2014, rather than the £24bn currently planned.

Remember that the Coalition announced that even these massive cuts, 58 per cent in real terms, were actually £2bn less that the plans inherited from Labour. I’d expect them to find £2-3bn more to slow the pace of this decline.But no, the real deal is undoubtedly whats occurring at Threadneedle Street. For the first time ever the Bank of England minutes released today showed the Bank actively discussing an “Operation Twist”.

And they also discussed giving a US Fed-like “explicit guidance” note that interest rates were on hold for years. For the first time since interest rates hit 0.5 per cent they discussed lowering interest rates even further. I was taken aback by paragraph 29 of the minutes.

Operation Twist is what we might get from America later today. It basically involves swapping the short-term government debt the US central bank has already bought through quantitative easing (QE), for medium and longer term debt, to help bring down longer term interest rates in the economy. The Bank of England considered it this month. In the end they didn’t go with it. It might be that the US Fed is a little stymied by political pressure from presidential candidates accusing it of “quantitative treasoning”. The Bank of England minutes suggest it can simply restart QE.

The other radical measures were not pursued by the MPC. But the mere fact that they were discussed is a clear signal that the BoE is thinking big. Cutting rates again to a new record was discussed but there are fears for the impact on banks, building societies and the normal functioning of money markets. No, all roads lead to more QE. But not just any old QE.

In Britain a further bout of QE seems to be positively being lobbied for by the likes of Vince Cable. But what’s the point of buying government bonds? The Operation Twist mention suggests the bank might buy long-dated government debt if, probably when QE is restarted. This should lower longer term interest rates.

But no, the real direction of travel is what I call Super QE, or what should probably called SM-QE. Directing the loosening of monetary policy towards lending to small and medium type businesses. Vince Cable wrote this pamphlet which floats ideas around using QE to buy bundles of SME debt or corporate bonds. Alistair Darling tried it in 2009, and then Mervyn King was not keen. If QE is to involve buying debts with credit risk, it is a fiscal matter, and one for an elected government to take. My sense is that this situation has not changed. But I have noticed no complaints from Threadneedle Street or the Treasury about Dr Cable’s musings. They chime rather nicely with the views of Adam Posen, a member of the Monetary Policy Committee.

The question therefore, is whether the Treasury and George Osborne are preparing for Super-QE where the Treasury assumes the credit risk for what is effectively the Bank of England lending tens of billions to companies. The sharp decline in world economic prospects makes me think they are. Plan BoE, not Plan B.

Follow Faisal Islam on Twitter @FaisalIslam

11 reader comments

  1. Jon da Silva says:

    QE to the banks as pushed by King and other bankers was a waste of public money.

    All the money pumped to the banks and stolen from savers via interest rates and for what? Just as bankrupt banks with even more liabilities and rising fuel and food prices from speculative pressure QE created by allowing them to gamble more. Increasing heroin portions for heroin addicts would be a parallel.

    These rogue traders belong in jail.

    No more bail outs to non ring-fenced banks please.

  2. Brian Cunningham says:

    Hi Faisal,
    How about showing us a graph, say once a week, which tracks the UK’s progress on deficit reduction?
    We’re having to live with belt-tightening all round, yet we’ve no idea what progress we’re making towards the stated goal of eliminating the deficit in the term of his government.
    Keep up the good work.
    Brian

  3. Andrew Dundas says:

    As usual there is a wide difference between economic management of the Coalition – which still includes St. Vincent – and the policy of the BoE.exchanging for cash. Whereas the Lib Dems & Tory partnership still favours cutting investment to below the normal rate of replacement. Which is the 1930s policy that ended so disastrously in mass bankruptcies and dire poverty.
    It is both harder and more expensive to halt stagnation and decline with QE, because that doesn’t directly encourage businesses to invest in more staff and new kit. What’s needed to stimulate those investments is rising sales to their customers. Or at least the good prospects of recovered customer demand.
    The big idea of the Lib Dems & Tory partnership is to lay-off lots of workers and cut the incomes of the poorest. That’s to make room for cuts in Corporation Taxes so dividends can be increased. But it will also reduce spending and the sales growths that are needed to persuade businesses to invest.
    Will the BoE’s policy work? It’ll certainly put more cash into the system and lower long-term rates too. But not enough.

  4. muggwhump says:

    This is what a ‘recovery’ looks like when consumers can’t or won’t use their credit cards to fuel economic growth.
    Lets be honest about this we’re no longer in recession, the financial system has been bailed out with hundreds of billions of our money borrowed from our kids and grandchildren, the panic is over and this is what growth looks like when not fuelled by a credit boom.
    But its not good enough for the bankers or those at the top who are worrying about the value of all those lovely assets they own.
    So the answer it appears is to print more money.
    Remember the last bout of QE? It was, we were told, vital to print money in order to fend off perceived deflation, stimulate inflation and we were promised it would lead to growth of 3.5% a year by now.
    Well apart from the inflation we were promised – thanks for that – I fail to see any other signs to show for it.
    You have to remember that QE isn’t some kind of ‘magic bullet’, there is a price to pay for printing money and that as we all know is inflation. At least part of the reason our recovery has been so weak is that consumers who have to start ‘living within their means’ are finding those means getting tighter…

  5. Jim Flavin says:

    All this is virtually exactly as Pter Schif forecast five years ago . Priting money IMVHO is diastrous = devaluation . Anyway everything in most economies now is guided to protecting the Rich . What is needed is a Roosavelt style New Deal – but that is so far from neo – cons like Cameron that it will not happen – unfortutely . It is only way out – and wahtever you think of Hitler and his other atrocities – he got Germany out of a worse depression than this – but the politicins are tied to a dogma that has failed ie Deregulation / Moneytraism – and they cling on saying whar caused the disease will cure it – No – It wont .
    Maybe Perry or Bachmann or Obama will introduce a New Deal . IMO – they will – and it will be called Iran . Always the way – when things go bad at home – start another war abroad – even tho those wars are a big part of Deficit Problem

  6. Charles Jurcich says:

    They discussed lowering the Bank Rate, which I presume they mean targeting the support rate as in Japan (in their case the support rate is 0%).

    This would effectively make the interbank market (in UKPs) irrelevant as banks could simply get reserves anytime they want from the BoE without penalty – why then, would they be worried about this? It didn’t hurt Japan.

    Are they in some way relying on the interbank market to help them recapitalise or boost profits? Is it something to do with foreign currencies? I’d really like to know the answer to this.

  7. Jamal Barry says:

    Spooky! Very prescient comments on ‘credit-easing’/SM-QE, that crystal ball was a good investment, Faisal!

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