UK Economy: BOE Cuts Interest Rates & Prints Money

London, 6 Mar. The Bank of England slashed interest rates to an unprecedented low of 0.5% on 5 March, 2009. It also announced plans to increase the domestic

London, 6 Mar. The Bank of England slashed interest rates to an unprecedented low of 0.5% on 5 March, 2009. It also announced plans to increase the domestic money supply through quantitative easing – which is almost like printing money.

Any central bank’s main tool in regulating monetary policy – to control inflation, liquidity, spending, and even inflation – is the federal funds target rate, which is just a fancy way of saying “interest rate”. The lower it is the easier funds will be for banks (and subsequently consumers) to borrow. This will encourage more lending and spending.

So the Bank of England has made a further interest rate cut, from 1%, down to half a percent. This is rock-bottom. Some would say it’s dangerously low, because once this hits zero, the central bank has lost its main tool as it cannot go any lower. Then, the country faces problems similar to those in Japan less than a decade ago like the liquidity trap, but that’s another story.

Printing money is a great way to cause hyperinflation, Mugabe style. But the Bank of England is only extending banks’ credit lines and buying government securities and corporate bonds. The catch is it’s buying these assets without borrowing any money to do so – creating money out of thin air.

This gives the banks the assurance they have plenty of liquidity. These excess reserves then give the bank the security it needs to know it will not run short of liquidity, and it can be safe lending to the public. Now banks can stop hogging the money and can let it out to private borrowers.

However, inflation is a real risk of quantitative easing, just as it is when a bank prints money. If money is easily available, prices rise. But that’s the least of the Bank’s worries, and could even be a necessary evil given the dire circumstances. Bank of England Governor Mervyn King said in a central bank announcement, “In these highly uncertain times, there are merits to stimulating the economy through a variety of different channels.”

“Accordingly, the committee also resolved to undertake further monetary actions, with the aim of boosting the supply of money and credit and thus raising the rate of growth of nominal spending to a level consistent with meeting the inflation target in the medium term,” the bank announced in statement alongside the rate decision.

The inflation target for the medium term was reportedly 2%, and the interest rate cut alone was not forecast to keep inflation at that level. This action is expected to introduce £75 billion into the UK economy over the next 90 days via government bond purchases. The shadow chancellor George Osborne said, “It’s a leap in the dark. It’s effectively printing money, but because all the other government policies haven’t worked, I don’t think the Bank of England was left with any other options.”

Umberto Osman, EconomyWatch.com