Bank of England may stop printing money

by Ed Bowsher on 09 July 2009  |  2 comments
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It looks like the Bank of England is about to stop 'printing money' - for now at least. That could be a sign that inflation is now our No.1 economic problem.

The Bank of England said today its base rate would stay at 0.5%. No surprise there. The more interesting part of today's statement was on 'quantitative easing'  - the Bank of England's programme to create new money to boost the economy. (This is known colloquially as 'printing money' although no extra notes have actually been printed.)

The Bank has been using its newly-created cash to purchase UK government bonds known as gilts. Before today, the Bank had said that it would spend up to £125 billion buying gilts. Many pundits had thought that the programme would be increased to £150 billion today.

But that hasn't happened. Instead, the Bank will carry on with the previously announced programme and 'only' spend £125 billion. All that money should be spent within the next month. Then in August, the Bank's boffins will review the situation and decide whether quantitative easing should continue or not.

It's too early to say that quantitative easing will definitely end in August. We can't be certain about the outcome of next month's review. The one thing I am certain about is that it will be a difficult decision.

That's because there are always 'lags' when it comes to decisions on interest rates, exchange rates and printing money. Economists say that you can't be sure about the impact of an interest rate cut until a year or more after the cut.

So when the boffins review quantitative easing next month, they will be trying to look ahead to August 2010. On the one hand, if they stop quantitative easing this August, it's possible that the economy could lurch back to a more serious recession. But if they carry on printing money when it's not necessary, inflation could start to take off in late 2010 or 2011.

It's a tough call. Especially since the current financial crisis is unchartered waters, so looking at what happened in previous economic cycles isn't terribly useful.

That said, today's news suggests that the Bank is beginning to fret more about inflation rather than deflation.

If that trend continues, financial markets will probably start to worry more about inflation too. Then  rates on long-term government bonds would rise further and that would feed through to higher rates on fixed-rate mortgages. Indeed, we've already seen rate rises for fixed-rate mortgages over the last month - in anticipation of higher inflation and interest rates.

That said, it's important not to get carried away. Today may prove to be a watershed moment in the history of the current financial crisis. But if the Bank decides next month to carry on with quantitative easing after all, July 9th 2009 will just be a historical footnote.