Potential Impact of BOE Asset Purchase Plan on Sterling
Normally, when a central bank wants to influence a country’s interest rates and/or the value of its currency, it uses monetary policy to do so. Lowering the interest rate is a very popular way for central banks to stimulate a sluggish economy.
When interest rates are very low, i.e. start approaching zero, this no longer becomes an option. This is why the BOE had decided to resort to an asset purchase plan to try to infuse some life into the UK economy. What happens is simply that the Central Bank buys financial assets from banks and other financial institutions with money it literally prints. At the beginning of October, the bank decided to expand its assets purchase plan by buying a further £75 billion of these financial assets.
With the UK inflation rate already hovering near 5 per cent, the danger is of course that this can push inflation beyond acceptable limits. Given that the economy is operating way below peak levels at present, this is not likely.
To be effective, the additional money pumped into the banking system should be used by banks to finance productive assets, for example new business start-ups and the expansion of existing businesses. If banks remain reluctant to lend out money, it will not have the required effect on the economy.
The asset purchase plan further carries the risk of depreciating the value of the British Pound, since the supply is increased without a corresponding increase in demand. Exporters will appreciate this, because it makes their exports cheaper. Importers and the general public who have to pay more for imports might not be equally excited about the idea.
If we look at Fig. 10.31(a) we see that the British Pound moved mainly sideways between January and the end of August 2011. On the 5th of September, it dropped below the Ichimoku Kinko Hyo cloud and closed at 1.60981. From there it was downhill for most of September, until it briefly touched 1.52708 on the 6th of October.
Since then it has recovered most of its losses and it is currently trading at the same price it traded a little more than eight months ago.
The problem with predicting what effect something like the BOE asset purchase plan will have on the British Pound is that what happens to the Euro often has a bigger effect on the Pound than UK monetary policy.
The financial rescue plan drawn up by the EU and the latest agreement to write off 50 per cent of Greek debt will tend to strengthen the Euro. We can clearly see this in Fig 10.31(b), where the Euro jumped from 1.38753 to 1.41726 on the 27th of October. On the same day, the GBP climbed from 1.59571 to 1.60833.
Coming back to Fig 10.31(a), we see that the GPB is currently trading above the Ichimoku Kinko Hyo cloud. The green Chinkou Span line is trading well above the price of 26 periods ago, indicating that we are in a bull phase – regardless of the asset purchase plan.
However, a cautious trader would require additional confirmation before entering a long trade. We have seen more than once that these stimulus packages only tend to have a short-term effect on the market and that fundamental issues tend to dominate in the longer run. The asset purchase plan might well still start exercising its downward pull on the GBP in the future.