RTTNews - Thursday, the Bank of England decided to hold its key interest rate at a historic low and to raise the size of quantitative easing measures by GBP 50 billion to GBP 175 billion.

At the end of the two-day rate setting meeting, the Monetary Policy Committee of the Bank of England voted to maintain the official Bank Rate paid on commercial bank reserves at 0.5% as expected. The rate now stands at the lowest level since the central bank was established in 1694. The previous change in the rate was a reduction of 0.5 percentage points in March 2009.

In light of latest Inflation Report projections and to keep inflation on track to meet the 2% inflation target over the medium term, the MPC judged that maintaining Bank Rate at 0.5% was appropriate.

Further, the MPC also agreed to raise the size of the bond purchase programme using the central bank reserves to GBP 175 billion from GBP 125 billion. The Committee expects the asset purchase programme to take another three months for completion. The scale of the programme will be kept under review, the central bank said in a statement.

Chancellor Alistair Darling authorized an increase in the ceiling of the asset purchase facility to GBP 175 billion from GBP 150 billion. This sets a maximum overall limit within which the central bank will determine the scale of the purchases each month.

The GBP 50 billion increase in scale of the scheme would necessitate an increase in the range of maturities of government debt that the Bank was willing to purchase.

The global economy remained in recession, though there have been increasing signs that output in the UK's main export markets is stabilizing. Although financial conditions remained fragile, financial market strains eased and banks' funding conditions improved. Household and business sentiment also picked up albeit from very low levels.

The MPC assessed that the recession in the U.K. appears to have been deeper than previously thought. GDP fell further in the second quarter of 2009, but the pace of decline moderated. According to official data, economic contraction in the second quarter was 0.8% which was much slower than the 2.4% decline in the first quarter of 2009. The National Institute of Economic and Social Research, a private think-tank, today said the British economy shrank 0.4% in three months to July.

Further, the MPC said, ...business surveys suggests that the trough in output is close at hand. There are signs that credit conditions commenced to ease, while lending to business has fallen and spreads on bank loans stay elevated.

Annual inflation in June had dropped below the central bank's 2% target for the first time since September 2007. Inflation eased to 1.8% in June mainly on account of lower food and energy inflation. The MPC also noted that past weakness in sterling continued to put upward pressure on inflation.

According to MPC, future development in output and inflation would depend upon the balance of two factors. One is considerable stimulus working through from the easing in both monetary and fiscal policy and also the past decline of sterling. On the other side, the requirement of banks to continue repairing their balance sheets would possibly limit the availability of credit, and past decreases in asset prices and high level of debt might weigh on spending.

The central bank said, While some recovery in output growth is in prospect, the margin of spare capacity in the economy is likely to continue to grow for some while yet, bearing down on inflation in the medium term. However, the recession and limitation in credit availability would possibly adversely affect on the supply capacity of the economy, moderating the rise in economic slack.

David Kern, Chief Economist at the British Chambers of Commerce welcomed the MPC's decision to increase the unconventional measures by GBP 50 billion. He added, This should be sufficient for the time being, but in view of the risks still facing the economy, more may be needed later in the year.

Commenting on the BoE decision, Richard Lambert, CBI Director-General said the MPC has been crunching the numbers for its quarterly Inflation Report and must have concluded that a further policy stimulus was necessary.

According to Peter Dixon, Commerzbank analyst, the central bank now holds the view that it is preferable to ease the strains on the economy first and worry about excess liquidity at a later stage. He said whether the quantitative easing policy will in the long-term prove successful or whether a repeat of the BoJ's experience awaits, is a question for the future.

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