BOE: Taking One Step Back… Or Forward?

Right now, the BOE‘s asset purchase program totals £175 billion, after the BOE insisted that the British economy needed even more stimulus amidst some signs of recovery. Adding £50 billion to their program last August caught investors off guard since many expected that there would be a maximum expansion of £25 billion only. The billion-pound question is: Are their easing efforts enough to stimulate economic activity?

Well, the increased liquidity does seem to be trickling down from banks to individuals as recent tallies show that the credit conditions in the UK have been favorable. Mortgage approvals have been consistently moving up as the number of new home mortgages approved by BBA-represented banks in September surged from 40,800 to 42,100, overshooting the 39,700 initial estimate. Public borrowing in the UK likewise soared to a high of £14.8 billion in September which puts its six-month score to a total of £77.3 billion. This is the highest figure ever recorded in more than six decades.

Despite the availability of financing, inflation in the UK continues to be subdued. In fact, it has been going farther away from the BOE’s 2% target. Year-over-year inflation, which measures the average change of price in a basket of goods and services, sat at 1.1% in September – its lowest level in five years! This only means that the central bank’s massive stimulus program is not doing much to stimulate output.

Would another expansion of the bank’s QE program be the solution? Although King has been openly advocating for even more stimulus, the BOE voted unanimously against a further easing in their September monetary policy committee meeting. But with recent data suggesting that economic conditions remain bleak, could the other BOE officials now push for more stimulus? It seems as if recent data is hinting that King will get his Christmas wish early…

For one, business investment refused to pick up despite the massive amount of stimulus measures injected into the economy by the BOE. Investment has slumped continuously for five straight quarters, with the latest report showing a decline of 10.2% between April and July. Given this trend, the upcoming results of the business investment report covering the third quarter of this year could play the same dismal tune. Second, instead of showing a 0.6% growth, retail sales for August remained flat for the second month in a row.

This leads me to the third point I would like to touch upon – the ugly results on UK’s third quarter GDP report. The preliminary GDP reading for the period covering July through September stood at -0.4%, in stark contrast to the expected 0.2% expansion. Since business investment and consumer spending make up a significant chunk of the country’s economy, this doesn’t bode well for economic recovery.

With their grim economic situation, the outlook for the British economy has turned so sour that further quantitative easing by the BOE might come as no surprise for traders. In fact, as early as Monday this week, traders may have started to price in their expectations of a £50 billion expansion of the BOE’s asset purchase program come Thursday. Yesterday we saw the UK’s manufacturing PMI climb from 49.9 to hit its two-year high at 53.7 but the pound was unable to make significant headway. Traders probably thought “An expansion in manufacturing? That’s bollocks. Our GDP is still negative, for crying out loud!”

On another note, word on the grapevine is that some officials are worried about over-stimulating the economy and causing a housing bubble similar to that of the US, which triggered this whole recession mess to begin with. Traders might buy up the pound if the BOE’s monetary policy members once again reach a unanimous vote to keep their bond purchases at their current levels. Would the BOE adopt a cautious stance just like it did in its previous policy statement?

With the UK sticking out like a sore thumb as the only major economy still wallowing deep in recession, the BOE can’t afford to be sitting on the fence anymore. At the risk of sounding like a 90’s pop diva, I’ll quote the Spice Girls on this one… “Too much of something is bad enough but too much of nothing is just as tough.” Seeing that the former isn’t the case for the BOE, perhaps they need to step it up a notch and be more aggressive in their efforts to spice up the economy.