BoE Cuts Rates To 0.5%, To Pump Money Into Economy

UK government bonds shot up on the news that the BoE would start so-called quantitative easing.

The Bank of England pledged to go on a 75 billion pound bond-buying shopping spree on Thursday in an unprecedented attempt to get the recession-hit economy growing again as it also cut interest rates to new record low.

Governor Mervyn King said the rate cut to 0.5 percent, the sixth in as many months, would probably be the last and the central bank was now switching to injecting money directly into the economy by buying assets, mostly gilts.

UK government bonds soared on the news the BoE would be starting so-called quantitative easing -- effectively printing money -- on such an aggressive scale over the next three months. Seventy-five billion pounds equates to around 5 percent of GDP.

Doubts remain over whether it will work but the BoE may have felt it had no choice -- the economy shrank at its fastest in nearly 3 decades at the end of 2008, house prices are sinking at record rates and hundreds of thousands of jobs have disappeared.

"The world economy has turned down very rapidly since last Autumn, the amount of money is not growing at all, and the economy is in a recession, so we need to increase the supply of money," King said on Sky Television.

The government set the BoE an initial overall limit of 150 billion pounds for new money it can create, though 50 billion of this is money which had been previously earmarked for the Asset Purchase Facility but will now be unfunded.

Quantitative easing has previously only been tried in Japan in the early part of the decade with limited success. But it has now become a watchword for central banks everywhere as interest rates near zero in the most serious world downturn for decades.

The European Central Bank also cut interest rates by 50 basis points to a record low of 1.5 percent on Thursday. U.S. interest rates are between 0 and 0.25 percent and Japan's are at 0.1 percent.

Many say the scale of the current downturn caught the BoE on the hop but it has acted swiftly and savagely since October when the collapse of U.S. investment bank Lehman Brothers sent shockwaves all around the world.

Interest rates have fallen by 4.5 percentage points to their current all-time low of 0.5 percent since then and are only stopping there probably because of worries that very low rates could have a counter-productive effect by hitting bank profits.

"The scale and timing of the QE operations appears significant, " said Ross Walker, UK economist at RBS.

"The lasting benefits for credit availability and demand are much more uncertain but, given the severity of the macroeconomic and financial backdrop, it is worth a try."

GILTS ON FIRE

The June gilt future settled 255 ticks higher on the day and yields on 10-year gilts fell 34 basis points, their steepest one-day fall in more than a decade, traders said. Sterling extended losses against the dollar, hitting a session low of $1.404 <GBP=>.

The BoE said it would buy medium and long-dated gilts and kick off the process with 2 billion pounds on March 11, targeting a variety of maturities so to not distort demand.

Gilt issuance is already at a record 146.4 billion pounds this year and could balloon further in the next financial year as the public finances are in really bad shape given the scale of the downturn.

The BoE said that even with the latest rate cut, there was a substantial risk of inflation undershooting the 2 percent target in the medium-term.

"It is blatantly clear that the UK economy needs as much help as it can get, given that it remains mired in deep recession with credit conditions damagingly tight," said Howard Archer, UK economist at Global Insight.