The market looked rather unimpressed with the Bank of England’s decision to expand QE by £25bn on Thursday.
As of lunchtime in London, the FTSE’s down 24.32 points at 5083.57. Sterling is at $1.6612 against the US dollar. The 10-year gilt yield is up 9bp to 8.877.
What gives?
Here’s a selection of early analyst reaction to give you some hints.
First, Thomson Reuters strategist Divyang Shah:
Given the split in market expectations between nothing, 25bn and 50bn the announcement today was always going to have a surprise factor of two-thirds. The fact that the BoE opted for 25bn once again highlights the contradictory nature of the whole QE programme; after all we had been told anything less than 50bn would constitute excessive fine-tuning. But given the fragmented nature of expectations the announcement today was not going to please everyone.
The 25bn coupled with the fact that the purchases are going to be paced over 3-months also highlights the low probability that QE will be expanded in the future. But given the way in which the economy has tended to surprise to the downside, the impact of higher unemployment and credit outlook it is never a good idea to write off the potential for further QE completely. Although the hurdle for a resumption of QE purchases beyond 200bn seems to be high at this point in time. The statement reads similar to that from the Fed overnight where the hawks have been appeased and in particular the reference to the impact to asset prices from “accommodative monetary policies” is interesting. This has been something that had been highlighted by those within the MPC looking for restraint on the extent of QE.
We now look toward the inflation report next week for further clues as to the outlook for policy but at this stage we are unwilling to rule out a resumption of QE next year. While we still try to understand how the BoE looks to measure the effectiveness of QE the focus is likely to turn to making existing QE more effective and this is likely to lead to a return to focusing on the reserve remuneration issue. This factor coupled with the fact that the move today signals that UK rates will stay “low for longer” continues to suggest that the short-end of the UK curve remains insulated. We had suggested a normalization with regards to 2y1y GBP vs 1y1y GBP and this continues to make sense. And IHS Global Insight’s Howard Archer, who also says this could be our last bout of QE:
Only limited fireworks from the Bank of England with the MPC opting to extend Quantitative Easing by a further £25 billion (to £200 billion) rather than increasing it by £50 billion as they had done at both their May and August meetings. We suspect that there may well have been significant divisions within the MPC over whether or not to extend QE, and by how much, given the current uncertainty as to the true state of the economy resulting from conflicting data and survey evidence.
The fact that the MPC decided to limit the increase in Quantitative Easing to £25 billion and to enact it at a slower rate over the next three months suggests that they believe that the economy is on a modest recovery track despite the shock third-quarter GDP contraction but could do with some extra help, especially as money supply growth and bank lending remain disappointingly muted. It may also be that the MPC are trying to gradually wean the economy off Quantitative Easing and are keen not to upset the markets by bringing it to an abrupt halt. This could have risked sending gilt yields up significantly, which the Bank of England would be keen to avoid.
We suspect that this will be the final extension to the Quantitative Easing programme unless the economy suffers a major relapse in 2010. The Bank of England may well be reluctant to further extend Quantitative Easing given recent stickier than anticipated inflation and sterling’s weakness, although the statement accompanying today’s decision indicates that the central bank still expects consumer price inflation to be limited for “some time to come” by substantial under-utilized capacity.
Meanwhile, interest rates seem set to stay down at 0.50% until at least the final months of 2010. Indeed, the Bank of England could very well delay raising interest rates until 2011. Furthermore, the eventual increases in interest rates are likely to be limited to counter the restrictive impact of the very tight fiscal policy that is need to rein in the bloated public finances.
And RBC’s Richard McGuire:
The BoE increased its asset purchase programme by £25bn at today’s meeting, taking the new limit to £200bn. This is expected to tide the Bank over for the next three months (i.e. to run approximately up to the next Inflation Report). The Bloomberg consensus had been for a £50bn increase although given this masked considerable differences of opinion amongst economists the average of £32.8bn might be a better expression of how the market was positioned.
The knee jerk reaction has been for the curve to bear steepen and sterling to rally - the former as the govt’s parlous supply-side backdrop is now coming back into view as the QE process effectively tapers off (the Bank having shifted down a gear from the recent £50bn over three month pace and the original £75bn) and the latter on the back of an implicitly less gloomy-than-expected economic outlook and an accompanying paring back of lower-for-longer-rate views.
With the DMO set to issue an average of £14bn worth of Gilts per mth going forward in order to fulfil this yr’s remit (£70bn of issuance remaining over the coming 5 mths) but the BoE now set to buy an average of £8.3bn per mth, the supply side concerns that have effectively been put on ice through the QE process will likely now come to the fore - a development that supports Gilt steepeners. We are about to enter the 3s-10s steepener currently under consideration in Global Directions in the wake of today’s announcement.
And finally, JP Morgan’s Malcolm Barr:
The £25bn extension saw no extension to the set of gilts which will be considered for purchase, and no change to Bank rate or mention of possible changes to reserve remuneration. Our best guess is that the reserve remuneration issue was discussed at this meeting, and the MPC have basically decided that a change is not worth implementing, and that will become clear in the Inflation Report press conference and the minutes. It is difficult to see why the issue would not have been brought to some form of conclusion by now.
The statement announcing the decision … should not be viewed as any signal about future intentions (the Inflation Report and minutes are more revealing in that regard), but as a reflection on the decision just taken. And, as is usual, the statement does little to clarify why today’s decision took its specific form (i.e. why the extension was £25bn rather than £50bn).
The statement that UK “GDP continued to fall in the third quarter” suggests that the MPC, informed by economists at the BoE who have done a lot of work on data uncertainty, see some information content in the preliminary ONS data. While a pick up in activity “may soon be evident” the committee still believes that “the prospect is for a slow recovery in the level of economic activity, so that a substantial margin of under-utilised resources persists”. While the statement mentions rising asset prices as a boost to growth, it does nothing to explicit suggest asset price concerns limited the extension of QE. Our best guess is that the vote here was 6-3, with King, Miles and Posen voting for a £50bn increase, with an outside chance that Dale or Sentance voted for no extension.More to come as we get it.
Related links:
More QE money based on money supply - FT Alphaville
Managing expectations, central bank edition - FT Alphaville
My King-dom for some central bank guidance - FT Alphaville
