We are a bit late to this, but here are selected highlights from Goldman Sachs prediction on Friday of further asset purchases by the Bank of England.
But this time Goldman economist Kevin Daly reckons there’s a good case for the BoE focusing on credit easing rather than the purchase of more gilts.
Amid renewed financial system stress and mounting evidence of weaker global growth, we now expect the MPC to engage in a second programme of asset purchases (QE2) in the coming months. We are also shifting back our forecast for the first rate hike from 2012Q4 until 2013 and further reducing our GDP growth forecasts, from 1.5% to 1.4% for 2011 and from 2.5% to 2.3% for 2012.
A serious concern for the MPC is that, having maintained policy rates at their floor for 2½ years and purchased £200bn in assets already, lending supply remains highly constrained and effective lending rates remain high (and are heading higher).
The MPC has argued that a key cause of the large spread between effective lending rates and policy rates is the high funding costs that banks face. In this context, we believe that a strong case can be made for focusing QE2 on ‘credit easing’ (directly targeting the credit spreads that cause the problem), rather than on the purchase of government gilts. However, the Bank is unlikely to choose this option, as it believes that credit market intervention of this type should be the responsibility of the fiscal authorities.
We’re guessing that the BoE could buy bank bonds (although it’s naturally been the role of the government to support the banks’ credit previously, via guarantees).
But if the BoE is unwilling to target bank credit spreads, then what precisely is the point of another round of asset purchases?
Daly doesn’t say but his central case is for £100bn of purchases over two quarters.
While we believe that QE2 would be significantly more effective if it were targeted on assets other than gilts, there are still likely to be significant positive benefits from a programme of this type.
And the subtext here must be that Goldman is a expecting a clear deterioration in the economic data over the next couple of months. That’s because the BoE’s monetary policy committee is highly unlikely to launch QE3 QE2 without it.
Update: 10.12am (London time)
And right on cue some gloomy economic data hits the wires – activity in the UK services sector slows at is fastest pace in more than a decade last month.
The Markit/CIPS services PMI headline activity index fell to 51.1 in August from 55.4 in July. This was the second-biggest fall on record, and confounded forecasts for a gentler drop to 54.0, although it remained above the 50-mark that divides growth from contraction.
And the ever reliable Howard Archer at IHS Global Insight:
This survey really rings the growth alarm bells. The very sharp slowdown in activity in services sector in August indicated by the purchasing managers’ survey is a particularly significant blow to the economy given the sector’s dominant role. Even allowing for any impact from the riots and a correction after a surprise spike up in services activity in July, this is a hugely disappointing survey. The only crub of comfort is that it shows services activity is still expanding.
It is not just that business activity expansion sharply to a 2011-low in August but also that incoming new business moderated, backlogs of work contracted, employment fell and business expectations sank to a 13-month low. The survey strongly reinforces belief that increases rates are staying down at 0.50% for a long time to come, and fuels expectations that the Bank of England will enact further Quantitative Easing. However, we believe that further Quantitative Easing still seems unlikely as soon as this Thursday given still significant near-term inflation concerns
Update: 10.46 (London time).
Michael Saunders at Citigroup weighs in with his thoughts on QE2.
Economic prospects have worsened materially since the August Inflation Report, with deteriorating trends in business surveys, weak consumer confidence and a sharp slide in equities. As a result, for the first time since end-2009, the upcoming MPC meeting is likely to have a serious discussion across the Committee over whether to expand QE further.
On balance, we believe (just) the MPC will not expand QE at the September meeting, but we consider it is a much closer call than markets currently assume. The August Inflation Report argued that inflation will return to target even if growth picks up, hence pointing to scope to ease again if the recovery threatens to evaporate. We suspect the MPC will be nervous about easing with inflation so far above target and above their forecast, and hence will wait to see a bit more evidence on the economy’s prospects. But these inflation worries could be over-ridden — leading to extra QE at the September meeting — if further signs emerge of downside risks to growth, especially if equities slide further or the services PMI mimics the sharp drop in the EC survey.