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5 must-know facts about quantitative easing

£75 billion Bank of England boost to the economy

bank of england

The Bank of England is injecting another £75 billion into the economy

At the end of another week of economic turbulence, we answer your questions on the Bank of England’s quantitative easing programme.

Why is quantitative easing in the news again this week?

The Bank of England announced on Thursday that it was planning to boost the economy by injecting a further £75 billion through quantitative easing (QE).

Some £200 billion of QE has already been added to the economy by acquiring assets such as government bonds, in an effort to encourage lending by commercial banks. This is the first time that the quantitative easing programme has been extended since 2009.

How does quantitative easing work?

A central bank (the Bank of England in this case) buys assets (usually government and corporate bonds) using money it has created. Commercial banks and insurance companies selling those assets will then have ‘new’ money in their coffers, which will increase the money supply.

The result should be that as the Bank buys bonds, it reduces the supply of those bonds in the market and therefore increases demand. As the price of the bonds rises, the yield (or return) on them falls. Many interest rates (including mortgages) are set with reference to gilt yields, so the net result should be cheaper borrowing costs.

Banks will also have more money in their accounts and hopefully lend more to businesses and individuals, giving the economy a timely boost. There is, however, the danger that QE might push up the inflation rate.

Why the latest round of QE?

The latest round of QE comes on the back of recent turmoil in Europe and a torrid time in the UK markets. The Eurozone crisis is ongoing, with several countries teetering on the brink.

Our own economy shows few signs of improving – the latest GDP figures having been revised downwards to 0.1% growth for the second quarter of 2011.

Mervyn King, governor of the Bank of England, has said this week: ‘This is the most serious financial crisis we’ve seen at least since the 1930s, if not ever.’

Will quantitative easing work?

This depends on where you sit on QE. The initial programme did see the UK exit recession, but lending to businesses and individuals has remained slow. Bank of England figures estimate that the initial wave of QE, totalling £200 billion, boosted gross domestic product (GDP) by around 1.5 percentage points.

Why is QE bad news for pension schemes?

The purchase of gilts (government bonds) via the QE programme has pushed up their value and reduced their yield. This looks set to reduce the returns produced by pension funds, which invest heavily in bonds.

Employers and employees will need to increase contributions to final salary and money purchase pension schemes respectively. The fall in yields will also serve to push down annuity rates even further.

The National Association of Pension Funds has called an emergency meeting with the Pensions Regulator to discuss the implications of QE on pensions funs and whether they can be protected.

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