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Thursday, the Bank of England retained its key interest rate at a record low and decided to continue its GBP 175 billion asset purchase programme intact, as expected, in an effort to support the fragile British economy.
At the end of its two-day rate setting meeting, the Monetary Policy Committee held the official Bank Rate paid on commercial bank reserves at 0.5%. This has been the lowest rate since the central bank was established in 1694. The previous change in the key rate was a reduction of 0.5 percentage points in March.
Policymakers also decided to continue with its programme of asset purchases totaling GBP 175 billion financed by the issuance of central bank reserves. The central bank expects the programme to take another month to complete and will keep the scale of the programme under review. The minutes of today's meeting will be released on October 21.
Most analysts now expect the central bank to re-assess the size of the quantitative easing measures next month, after getting more information on the inflation outlook. The central bank's quarterly Inflation Report is due on November 11.
Initially, the central bank had introduced a GBP 75 billion programme of asset purchases on March 5. Later, the size of the quantitative easing was raised to GBP 125 billion on May 7 and again to GBP 175 billion on August 6. So far, the central bank has purchased assets worth GBP 162 billion under the scheme.
In August, the GBP 50 billion increase in asset purchase programme surprised the market. Governor Mervyn King and two others had sought a larger increase of GBP 75 billion to GBP 200 billion in August. But in September, policymakers unanimously voted to continue the GBP 175 billion quantitative easing and to hold the key rate at historic low.
Commenting on today's decision, David Kern Chief Economist at the British Chambers of Commerce said the reluctance of the central bank to raise the quantitative measures beyond GBP 175 billion was disappointing. The business lobby had earlier urged the MPC to increase the QE measures to GBP 200 billion and to consider a lower or even a negative interest rate on deposits held by commercial banks with the central bank.
Commerzbank analyst Peter Dixon expects a signs of recovery in overall activity rates over the near-term with the third quarter expected to post a small positive rate. On the assumption of either flat or marginally positive GDP growth in the third quarter, the analyst sees little need for an expansion of the asset purchase programme. An additional GBP 25 billion of asset purchases amounts to less than 2% of GDP and is trivial in the light of what has already been done, said Dixon.
According to Commerzbank, expectations that the central bank will not announce an extension to asset purchases could put downward pressure on gilts. At the same time, Commerzbank do not anticipate that the BoE will entirely close the door on asset purchases, and may simply pause the scheme with the option to resume purchases at a later date should economic conditions warrant.
Confederation of British Industry's Chief Economic Adviser Ian McCafferty said, "It is as yet early days in gauging the effect of the QE program so far, but companies are still facing serious constraints in their financing, so the Bank must take no risks in ending the programme prematurely."
Recent economic reports suggest improvement in British economic activity. In September, consumer confidence in the UK improved to its highest level since April 2008. The consumer confidence index rose to 71 from 65 in August. A survey from the Chartered Institute of Purchasing and Supply and Markit Economics found that the service sector activity expanded at the fastest pace since September 2007.
But, disappointing manufacturing output data raised concerns over recovery in the third quarter. Manufacturing output slipped the most since January 2009. Output was down 1.9% on a monthly basis in August, in contrast to the 0.7% growth seen in July.
While, Japan, Germany and France moved out of recession and expanded in the second quarter, the British economy showed a decline in GDP during the period. The UK economy contracted 0.6% sequentially in the second quarter. On a yearly basis, GDP declined 5.5% in the second quarter, the biggest since records began in 1955.
Today's decision came exactly a year after seven major central banks reduced its interest rate in a co-ordinated move after the collapse of Lehman Brothers. While central banks around the world kept its interest rates at low levels to support recovery, the Australian central bank became the first among the G-20 nation to hike its interest rate, earlier this week.
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