The Bank of England, concerned about the pace of a fragile recovery, decided to expand its bond purchase program by £75 billion. That brings the total quantitative easing program up to £275 billion pounds. This shows that the central bank is more concerned about faltering growth, and a possible dip back into recession, than it is elevated inflation readings (inflation was at a 4.5% annual rate in August). In fact, the concern for the bank is that inflation will undershoot the 2% target in the medium term.
From the Release: In the United Kingdom, the path of output has been affected by a number of temporary factors, but the available indicators suggest that the underlying rate of growth has also moderated. The squeeze on households' real incomes and the fiscal consolidation are likely to continue to weigh on domestic spending, while the strains in bank funding markets may also inhibit the availability of credit to consumers and businesses. While the stimulatory monetary stance and the present level of sterling should help to support demand, the weaker outlook for, and the increased downside risks to, output growth mean that the margin of slack in the economy is likely to be greater and more persistent than previously expected.
The deterioration in the outlook has made it more likely that inflation will undershoot the 2% target in the medium term. In the light of that shift in the balance of risks, and in order to keep inflation on track to meet the target over the medium term, the Committee judged that it was necessary to inject further monetary stimulus into the economy.
This decision comes a day after a report showed the economy barely grew in the 2nd quarter. GDP rose a very tepid 0.1% in the final reading. The outlook for the economy, without action by the central bank, did not hold much promise as consumers continue to be squeezed by high inflation and low wages, unemployment has begun to pick up, trade has not provided offsetting growth that the government and the central bank expected, and we continue to have the government pushing its strong austerity measures which will put further strain on the economy.
The pound had a sharp reaction as a result of this decision. The GBP/USD fell from just below 1.55 prior to the decision down to 1.5265 in the immediate aftermath, a new low for this week. The EUR/GBP jumped to 0.8730. The pound was weaker against other rivals - the AUD, JPY, CHF, and NZD - as well.
The pound has been on the decent against the dollar over the last month and a half and had already fell from a high in August of 1.6590 all the way down to 1.5450 prior to the release on the back of expectation that the bank would undertake more quantitative easing. The question was whether the Monetary Policy Committee would do so in today's meeting or if they would wait till perhaps November so they could assess more data. It seems that the central bank has decided to act proactively and decisively, pulling the trigger on this policy action.
The GBP/USD punctured the lows we had in September for the GBP/USD pair and that opens up further downside risk for the pair. A weekly close under 1.5330 could signal a deeper fall towards 1.4900, according to ForexLive. According to Morgan Stanley, the timing and extent of the measure will put cable under pressure, as it was widely expected that the bank would wait until November. The 1.53 level is now key support and the GBP/USD is now open to a bigger move to the 1.5175-1.5125 area.
The program will take about 4 months to complete, and the BOE will spread its buying evenly over bonds in three different maturity ranges. The question now is whether the BOE will decide to increase the size of purchases yet again after this bout of bond buying is complete. That sets up a key BOE decision to watch in February.
Chief Market Analyst