In Wednesday’s Bank of England inflation report comes a more thorough explanation to last week’s surprise quantitative easing boost (our emphasis):
At its August meeting, the Committee noted that the immediate prospect was for CPI inflation to fall substantially below the 2% target. Output appeared to be stabilising and the substantial stimulus from the easing in monetary and fiscal policy and the past depreciation in sterling should support a slow recovery in economic activity. But the margin of spare capacity in the economy was likely to continue to grow for some while, bearing down on inflation. In the light of that outlook, the Committee judged that to keep CPI inflation on track to meet the 2% target in the medium term it should maintain Bank Rate at 0.5% and increase the size of the programme of asset purchases financed by the issuance of central bank reserves to a total of £175 billion.
Meanwhile, there was also the relatively unchanged picture in M4 money growth — a key factor underpinning potential deflationary pressures — to address. Since the start of the Bank’s asset purchases, the growth rate has remained weak (see chart below). As the Bank states:
One potentially useful diagnostic of the impact of the Bank’s asset purchases is the extent to which they boost the stock of broad money. Broad money growth remained weak in Q2 (Chart 1.3).(2) That reflected continued underlying weakness in nominal demand: nominal GDP fell by 3% in Q1, and is likely to have fallen further in Q2. Absent asset purchases, it is likely that money growth would have been even weaker.
Interestingly, the Bank believes the reason for that was mostly due to actions of private non-financial corporations (PNFCs). As the report explains:
One process that is likely to have depressed money growth in Q2 is private non-financial corporations (PNFCs) using the proceeds of net equity and bond issuance to pay down bank loans. PNFCs’ net issuance of bonds and equity increased markedly in Q2 (Section 1.4). Despite that, their deposits were little changed (Chart 1.4). Reports from the Bank’s regional Agents suggested that could be because some PNFCs had used the proceeds of their bond and equity raising to pay down bank debt, rather than hold it on deposit. That is consistent with the fall in outstanding PNFC bank debt in Q2.
But also the banks:
Another process that may have restrained broad money growth in recent months is banks’ attempts to strengthen their capital positions. When non-bank investors purchase newly issued bank equity or long-term debt, that reduces non-bank money holdings and hence M4. It appears that investors have sold gilts and bought bank assets in recent months: the non-bank private sector reduced its holdings of gilts in Q2 (Chart 1.5), and financial flows data indicated that banks’ net sterling liabilities excluding deposits, which include bank equity and long-term debt, increased.
The other deflationary alert also comes in the fact that net lending to PNFCs and households is now as bad as it’s ever been:
And on top of that the UK has had to deal not only with major UK lenders cutting back on lending but some foreign lenders withdrawing from the UK market entirely. As the Bank states:
These lenders played a key role in the expansion of credit over 2006–07, but their lending has since fallen back sharply.
Related links:
Double secret QE - FT Alphaville
QE in pics – FT Alphaville