Bank of England to Hold Rate, Boost Bond Buying

The Bank of England looks likely to expand its 125 billion pound quantitative easing program and keep interest rates at a rock-bottom 0.5 percent on Thursday to sustain its attempts to lift Britain out of recession.

The newly created money — which the Bank has used to buy government bonds and corporate debt to encourage lending to the rest of the economy — will all be spent in two weeks unless the BoE slows down asset purchases.

So economists expect the central bank to take the stop-gap measure of expanding the scheme by 25 billion pounds, which will allow asset purchases to continue through to next month's rate meeting, when policymakers will have a new set of quarterly economic forecasts to aid a longer-term decision.

"It is a nailed-on certainty that the Bank of England's Monetary Policy Committee will keep interest rates unchanged at a record low of 0.50 percent on Thursday," said Howard Archer, economist at IHS Global Insight.

"However, we believe that there is a very strong possibility that the MPC will expand the bank's Quantitative Easing program by a further 25 billion pounds to 150 billion."

Britain's economy is no longer in the freefall that prompted the Bank of England to launch QE in March, but there is no clear sign of a recovery either.

Industrial output recorded an unexpected, sharp fall in May after a rising for the first time in over a year in April, while service sector measures are only consistent with anemic growth.

Unemployment is at 7.2 percent of the workforce and rising, while modest signs that banks are starting to lend more freely have not changed the BoE's view that a credit shortage is still one of the biggest challenges to sustained growth.

Sharon Lorimer

However, even the BoE accepts that evidence QE has played a direct role in boosting lending is limited, making a major expansion of the program a difficult call.

While gilt markets' central scenario is for the BoE to expand QE by 25 billion pounds, there is the risk that it could do more or nothing extra at all.

From a macroeconomic point of view, leaving a gap in asset purchases between late July and early August, when the BoE will have more data, would do little harm.

But it would risk causing market turmoil unless the BoE carefully communicated that it was delaying a decision rather than ending QE altogether.

This could be difficult to finesse in the very brief statement that the BoE typically issues to outline its QE policy and rate decision at 1100 GMT.

Moreover, no policymaker has suggested that existing levels of QE pose an inflation danger which would justify winding up the scheme rapidly.

Raising the Amount?

Some economists argue by contrast that the BoE will look more decisive if it announces more than 25 billion pounds of extra quantitative easing on Thursday.

But this would break the pattern of past changes in BoE QE policy, which have been timed around the availability of new forecasts in its quarterly inflation reports.

A halfway house for the BoE could be to say it has formally requested finance ministry permission to raise the QE total beyond 150 billion pounds, but delay the decision of whether to implement this until next month, said Archer.

But other economists, such as Deutsche Bank's George Buckley, are far less certain that the BoE will want to go beyond 150 billion pounds in the immediate future.

Instead, a 25 billion pound increase — smaller than March's initial 75 billion pounds and May's 50 billion — would be a signal that QE was coming to an end, at least temporarily.

"The MPC is likely to adopt a path of least disruption to the market and the nascent recovery process and use the final tranche of 25 billion to ease its way out of the Asset Purchase program while keeping the door open for additional purchases," Buckley said.

• Special Report: Boom, Bust & Blame

Copyright 2009 Reuters. Click for restrictions.