MPC right to put QE on hold, says F&C's Scott

Ted Scott, Director, UK Strategy, F&C: Yesterday the MPC decided not to increase the programme of quantitative easing from the current £125bn to £150bn, the maximum permitted.

There was also some speculation ahead of the announcement that the Committee would seek to increase the allowable limit beyond £150bn because the perception was that thus far QE has had little effect in injecting liquidity into the economy. Instead the MPC said it would complete the current programme and then review it at the next meeting.

The reaction in the gilt market was one of disappointment and yields rose sharply on the absence of further aggressive buying by the Treasury. The market's expectation was based on the lack of evidence that UK lending is responding to the injection of liquidity via QE. In this respect I believe the failure is not because the QE programme is too small but because the conduit for enabling the extra money supply to get into the economy is not working effectively.

The sellers of bonds have mostly been institutions (many overseas) and much of the extra liquidity has been spent on other asset classes, especially equities, and has contributed to the rally in those markets. The banks are still hoarding cash as reserves in an effort to strengthen their balance sheets and restore capital ratios to adequate levels following the credit crunch. In this respect the problem for the MPC and the Government is to get the banks lending again and a normal flow of credit circulating around the economy again.

Therefore, I think the Committee is right to hang fire. The jury is out as to whether QE will succeed in its desired objectives but there is also a danger by being too aggressive too soon will result in raised inflationary expectations. If inflation takes off once the economy starts recovering it is a dragon that is very difficult to slay, as the UK economy learnt in the 1970's and 1980's. A balanced approach is correct for the time being and the MPC should concentrate on finding a way of persuading or coercing the banks to lend in the meantime.