The Bank of England surprised markets by announcing no expansion of its quantitative easing scheme on Thursday as it left interest rates unchanged at a record low of 0.5 percent for a fourth month running.
With the economy on course to shrink at its fastest pace since World War Two this year, markets had widely expected the BoE to increase its asset purchase target by 25 billion pounds, allowing it to continue to pump money into the economy until August when it publishes new quarterly economic forecasts.
But the central bank's Monetary Policy Committee said it would maintain the current program at 125 billion pounds for now -- the total is due to be completed over the next month -- and review the operation at its August meeting.
Gilt futures fell more than a full point and sterling rose around half a cent against the dollar as investors bet that the BoE is now done with QE. But analysts said the central bank may still choose to extend the operation when it prepares its quarterly Inflation Report next month.
We suspect that the BoE may use the cover of next month's Inflation Report to examine in more detail how well it is going and whether they should expand the program up to the 150 billion pounds level or perhaps, as we suspect, look to expand it beyond that amount, said James Knightley at ING. Median expectations from a Reuters poll last week suggested the central bank would spend 150 billion pounds on a program that would eventually prove to be effective. Only 16 of 57 economists said the bank would surpass the amount currently allowed.
Britain's economy is no longer in freefall, as it was at the turn of the year, but bank lending remains weak and a sustained recovery is far from assured, and so policymakers have said it is too early to declare victory over the recession.
Unemployment is still rising, manufacturing is still contracting and the recent pick-up in services activity may be little more firms re-stocking after running down inventory.
From a macroeconomic point of view, leaving a gap in asset purchases between late July and early August, when the Bank of England will have more data, will do little harm.