The Bank of England cut interest rates by 50 basis points to a record low of 0.5 percent on Thursday, and said it would pump 75 billion pounds of new money into buying assets, mostly gilts, in its battle with recession.
UK government bonds shot up on the news that the BoE would start so-called quantitative easing -- boosting the economy's supply of money through asset-buying -- on such an aggressive scale over the next three months.
Some analysts had anticipated a smaller early move but they said the BoE's hand had been forced by the severity of the economic downturn -- the worst in three decades -- while doubts remained over whether quantitative easing would work.
The government set the BoE an overall limit of 150 billion pounds for new money it can create, though 50 billion of this is money which had been previously earmarked for the Asset Purchase Facility but will now be unfunded.
Quantitative easing has previously only been tried in Japan in the early part of the decade with limited success. But it has now become a watchword for central banks everywhere as interest rates near zero in the most serious world downturn for decades.
The European Central Bank also cut interest rates by 50 basis points to a record low of 1.5 percent on Thursday. U.S. interest rates are between 0 and 0.25 percent and Japan's are at 0.1 percent.
Economists said the BoE would stop at 0.5 percent, after cutting by a total of 4.5 percentage points in six months, due to worries that very low rates could start having a counter-productive effect by hitting bank profits.
We expect this to be the final reduction in policy rates, with Bank Rate maintained at this level for a considerable period, said Ross Walker, UK economist at RBS. Overall, the scale and timing of the QE operations appears significant.
The lasting benefits for credit availability and demand are much more uncertain but, given the severity of the macroeconomic and financial backdrop, it is worth a try.
GILTS ON FIRE
The June gilt future shot up more than 350 ticks on the day and yields on 30-year gilts fell 45 basis points, on track for their biggest one-day fall this decade and possibly ever, traders said.
Sterling extended losses against the dollar, hitting a session low of $1.404.
The BoE said it would buy medium and long-dated gilts, starting the quantitative easing operations on March 11, and Governor Mervyn King said this would not get in the way of government debt issuance policy.
Gilt issuance is already at a record 146.4 billion pounds this year and could balloon further in the next financial year as the public finances are in really bad shape given the scale of the downturn.
The British economy fell into recession at the end of last year, shrinking by 1.5 percent in the last three months of 2008, its deepest contraction in nearly three decades.
The BoE said that even with the latest rate cut, there was a substantial risk of inflation undershooting the 2 percent target in the medium-term.
It is blatantly clear that the UK economy needs as much help as it can get, given that it remains mired in deep recession with credit conditions damagingly tight, said Howard Archer, UK economist at Global Insight.