QE is no silver bullet, says Capital Economics
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Further quantitative easing could boost confidence among financial firms, but will do little to help bank lending, says Capital Economics.
In its latest economics update, Vicky Redwood, senior UK economist at Capital Economics, says QE is the only policy tool now available to the Monetary Policy Committee, but in its current form it might be ineffective.
Some commentators have argued that further QE might do more harm than good, creating a bubble in asset markets, triggering inflation or eroding central bank credibility.
But Redwood says: “QE is no silver bullet. Nonetheless, we don’t view any of these arguments as a valid reason to hold off from extending the programme.
“There is certainly scope for further QE to have some positive effects.”
She says the MPC’s asset purchases appeared to narrow the spread between gilt yields and overnight indexed swap rates by over 50 basis points, but this gap has now reversed. Redwood argues that at the very least, restarting QE could widen this gap again.
But she says how much good extra QE does will ultimately depend on how bold the MPC is prepared to be - not only in terms of the amount of QE, but also what form it takes.
She says: “So far, the Bank has focussed almost exclusively on buying gilts. But given that it already holds about a quarter of outstanding gilts, it might now be open to the idea of buying a wider range of assets including more corporate bonds.”
But Redwood says even if the MPC undertook “QE2” with gusto the extra support will come too late to stop the recovery from slowing further in the near-term.
She adds: “And if - as is likely - the MPC is timid in its renewed attempts to boost the economy the chances of a strong recover are even slimmer.”
She believes the MPC has little choice but to preserve the QE programme, albeit in a different form.
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