More Quantitative Easing in the UK
With fears of another recession in the UK still very much a reality, it comes as no surprise that the Bank of England is doing all it can to stimulate the sluggish economy. Unfortunately it only has a limited selection of tools in its arsenal.
One of these is interest rates and under ‘normal’ circumstances all that is needed to increase demand and stimulate the economy during a downturn is to reduce the base rate. Theoretically, consumers and businesses will then take out more loans, which will have an expansionary effect on the economy.
When interest rates are very low or approaching zero, as in the current situation, this approach no longer works. This is when the Bank often resorts to quantitative easing, which involves buying financial assets such as bonds, from banks, in order to inject money directly into the economy. This literally involves ‘printing’ more money to help the banks increase their cash reserves.
On 6th February 2012 the Ernst and Young economic forecasting group issued a warning that UK bank lending will in fact fall during 2012. Predicting that loans to consumers will fall by 5.7% during the year.
One can thus not really blame the Bank of England for announcing, on 9th February, that it will inject a further £50bn into the UK economy by way of quantitative easing. This brings the total since 2009 to £325bn. As this is virtually the only tool left, it might well be used again in the near future.
For this to work we must, of course, have a situation whereby the banks actually increase loans to individuals and businesses. If business confidence levels are too low and the public remains fearful of debt, the money will simply remain stagnant on the banks’ books, without in any way stimulating the economy.
Effect of Quantitative Easing on the GBP
The downside of quantitative easing is that it might actually have an inflationary effect; it normally causes the currency of the country implementing it to be devalued against those of other countries.
Since an intended announcement of quantitative easing is often expected by the market beforehand, by the time it is actually announced the market has generally already priced it into the exchange rate.
If we study Fig. 2.10(a), an hourly chart of the GBP/USD exchange rate, we can see clearly that this is exactly what happened over the last few days.
Even before the Bank of England made its announcement, the GBP/USD rate started slipping. At 10 am on the morning of 8th February it was at 1.59274. By 11 pm, as the market started discounting the expected announcement, the rate had dropped to 1.58108.
Since then we have seen some profit taking, which has pushed up the price somewhat, but right now, on 10th February, it is trading at 1.57873.
The price is positioned well below the green Chinkou Span line and Ichimoku cloud and has also dropped below the price. The price is also beneath the red Tenkan Sen and the blue Kijun Sen lines. All of this confirms that the market might well be heading further south in the short term.
For a good medium term long trade wait for the price to recover above the recent maximum of 1.59274.