Britain's "quantitative easing" last resort to weather financial turmoil

Special Report:Global Financial Crisis

LONDON, March 6 (Chinese media) -- The Bank of England (BOE) slashed interest

rates to a record-low 0.5 percent on Thursday, while announcing the adoption of

an acute "quantitative easing" monetary policy. The measures were viewed by some

analysts as a last resort to pull Britain out of deep recession.

Under the "easing" plan, in the next three months, the BOE will put an

additional 75 billion pounds (105 billion U.S. dollars) into circulation to buy

company securities and medium-and long-maturity government bonds on the

secondary market.

In an extraordinary move, BOE Governor Mervyn King proposed pumping a

mammoth 150 billion pounds (210 billion dollars) into the economy, 100 billion

pounds (140 billion dollars) of which for buying government bonds and the rest

for company assets.

Under the "quantitative easing" monetary policy, a central bank increases

the amount of money in circulation to enhance liquidity and encourage private

banks to resume lending.

The policy was once pursued by Japan's central bank to fight deflation in

the early 2000 with limited success.

In the face of consumer spending slump and credit contraction, analysts

believed the BOE had no other choice but to take the risky step.

Britain entered recession in late 2008, the first time in nearly two

decades. Data from Britain's Office for National Statistics showed that the

country's Gross Domestic Product (GDP) shrank 1.5 percent in the fourth quarter

last year.

Standard Chartered forecast that domestic spending and business investments

will continue to fall in the first half of 2009, while economy would contract

2.9 percent this year.

The manufacturing industry has also fallen victim to credit crunch, with

over 40 percent of the country's enterprises saying they suffer particularly

tight financing conditions, Confederation of British Industries said.

The unemployment figure between October to December last year was 1.97

million, but the latest figure is believed to rise to 3 million as situation is

getting worse.

The bleak situation showed that interest rate cuts alone are far from

effective to pull the economy out of the mire.

The 0.5-percent interest rate is believed to have hit bottom, and further

cuts may trigger negative effects as it squeezes banks' profits and discourage

them from further lending, observers said.

However, a loose monetary policy is a must, otherwise Britain may risk

undershooting the target of 2-percent inflation rate in the medium-term.

With no better options at hand, BOE adopted "quantitative easing" as if to

inject adrenalin into an ailing economic body as a last resort.

In January, the government pledged 21.3 billion pounds (29 billion dollars)

of loans to help small and medium-sized enterprises, and another 2.3 billion

pounds (3.2 billion dollars) to save the auto industry. But the proposed

measures are yet to put into practice. The "quantitative easing" plan, even if

implemented immediately, is unlikely to take effect until the second half of the

year, the Standard Chartered said.

Printing more money might help easy immediate pains, but it cannot serve as

a panacea to remedy the deeper ailment, as was shown by Japan's experience,

analysts noted.

Pumping up money supply will supposedly increase the amount of deposits in

the private banks, and thus encourage them to lend.

However, the banks might use the money only to repair their balance sheets,

rather than lend or invest. In that case, money printing does nothing to

stimulate the stagnant economy.

Moreover, the financial sector, with limited capacity to absorb currency

flow, took up a large proportion of Britain's economy, causing a risk that the

newly printed money might flow to overseas markets instead of increasing banks'

liquidity, analysts said.

Experts also warned of the potential inflation caused by "quantitative

easing" measures. For now, money can be injected into the market when liquidity

is needed. However, when economy begins to revive, excess liquidity and

inflation are likely to ensue, causing another headache for the central bank.

Torn between the potential risk of the policy and a withering economy

crying for remedy, the BOE has watched closely the possible fallout of its risky

measures, and act with both prudence and boldness, analysts said.