Why more QE would be wrong for UK
IT is not looking good for the global economy, with manufacturing output slowing or contracting in most countries, including Britain. There is growing talk that the Bank of England could launch a fresh round of quantitative easing as early next week. If so, that would be a mistake. The British economy faces many challenges but it doesn’t need another boost to the money supply.
The Bank of England’s favourite measure of the amount of money circulating in the economy registered a 0.6 per cent rise last month, pushing annual growth to 2.2 per cent – the fastest since December. Of course, this remains feeble – and the quantity of money is falling after accounting for inflation of 5 per cent. As Simon Ward of Henderson, the fount of all wisdom on monetary data, points out, the quantity of money grew by 6.3 per cent annualised between 1998-2003 in the pre-bubble years; usually, that would be the kind of growth that would seem sensible and conducive to decent economic growth but lowish inflation. But what counts is not just the amount of money available (to buy goods or services or to invest in assets) – the rate at which money moves about from person to person and firm to firm matters just as much.
This – economists call it the velocity of money – has gone up significantly, compensating for the weak growth in the money supply. Velocity is rising because interest rates are so low and inflation so high that savers and companies don’t want to accumulate cash in bank accounts. In any case, Henderson’s broader measure of liquidity confirms that more QE is not needed. The total value of money as usually defined (cash and bank accounts) as well as Treasury bills, National Savings instruments, foreign currency bank deposits and other similar products grew by a healthy annual 4.5 per cent in July.
One could even plausibly argue that current rates of monetary expansion are too high to ensure the two per cent inflation target is met, at least until the Bank raises interest rates, thereby making deposits more attractive and slowing the rise in velocity. The other big worry about more QE is that it would merely force down gilt yields to even more ridiculous levels, wrongly suggesting that the cost of borrowing will remain at zero for ever. More QE would push sterling even lower; in the absence of much demand from the Eurozone for UK exports, the effect would be felt via higher import prices and higher inflation. Excess liquidity could also seep out of the UK and end up fuelling global commodity and food prices.
The UK economy faces lots of problems, none of which are due to a lack of liquidity: inflation at 5 per cent on the retail price index is slashing take-home pay and hitting demand, including for manufactured goods. Low interest rates are helping those with lots of floating rate debt but are hammering savers, whose income has been slashed. Companies are worried due to fiscal, monetary and Eurozone uncertainties. They are also facing ever-higher regulatory costs. Elevated levels of public spending, sky-high marginal tax rates and an exploding national debt are all slowing activity. Demand for UK exports is weak. While still no disaster, it is not a pretty picture. Rather than another massive dose of pump-priming, what the UK really needs is lower inflation, a supply-side revolution – and above all a really big dollop of good luck.
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