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The big news of the session is that the Bank of England has embarked on more QE for the first time in two years. The Committee has made a bold statement, the market had expected GBP50bn of asset purchases next month but the Bank thought that the tensions in world economy threatened the UK and the banking sector to such an extent there was no point waiting until November and the amount of stimulus should be a larger GBP75bn.
The Bank has opened itself up to criticism that it is stoking inflation. In its letter to the Treasury it said that it expected prices to exceed 5% in the next month or so, however it was firm in its opinion that inflation will fall back next year saying The deterioration in the outlook has made it more likely that inflation will undershoot the 2% target in the medium-term. Thus, the MPC is extremely worried about the future trajectory of economic growth, and has not been placated by the stronger than expected PMI readings for September, which showed the manufacturing and services sectors had staged a modest recovery after slumping in August.
The Bank said that the new GBP75bn of asset purchases will take four months to complete, and opened the door to more stimulus if the economic outlook fails to improve saying the scale of the program will be kept under review. The pound fell sharply on the news, dropping 200 pips to 1.5300 against the US dollar, it also collapsed against the euro and EURGBP is back above 0.8700 at the time of writing.
Overall, we thought there was a 30% chance of more QE today, instead expecting the Bank to wait for its Inflation Report next month and its lower inflation forecast to justify further easing. Today's move is brave, the BOE is playing a dangerous game and its credibility is definitely on the line. The MPC said that funding concerns in the banking sector also spurred its move, and more QE could help loosen credit conditions and help banks lend to consumers. However, with inflation expected to top 5%, higher prices may put consumers off spending in the medium-term.
The question now will be has the BOE jumped the gun. We may see a further improvement in the economic data in the coming months and the EU authorities seem to be pleasing the market with their quick action on a unified effort to re-capitalise the banks. But risks remain including a further growth scare and a default in Greece.
So if the economic outlook fails to improve then the Bank will be hailed for its good judgement and foresight and the BOE's move could be a pre-curser for action from the Fed and the ECB.
In the short-term QE is traditionally negative for FX and the pound is likely to wither towards 1.5000 versus the USD. This should be good for UK banks and thus boost the FTSE 100.
Kathleen Brooks| Research Director UK EMEA | FOREX.com
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