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How does QE help the coronavirus problem?

  • Describe the significance of QE
  • Explain the Bank of England's actions towards corporate bonds
  • Describe stagflation
CPD
Approx.30min
How does QE help the coronavirus problem?

The Bank of England announced on March 19 that it was cutting the UK base interest rate to a record low of 0.1 per cent as part of its ongoing battle against the economic consequences of the Coronavirus

But JP Morgan Asset Management's Karen Ward believes the announcement of additional quantitative easing measures, made at the same time, will have a far greater impact.

As part of the package announced by the central bank, it agreed to buy an additional £200bn of UK government bonds, bringing the total it will own to £645bn.

Chancellor Rishi Sunak’s rescue package for the economy, meanwhile, involves spending plans that will cost hundreds of billions of pounds to deliver.

The money to fund this comes from the UK government issuing new bonds, which investors buy in exchange for an annual income.

The UK government has been issuing new bonds every year for the past decade, and usually has no problem selling them.

But selling hundreds of billions of pounds more of this debt, in a climate where the value of sterling is falling, and investors are wary of taking any risk, may have proved a challenge.

And it is likely that the interest rate the government would have had to pay on the debt would have risen sharply, creating far higher costs for the future. In the minutes of its most recent Monetary Policy Committee (MPC) meeting, published on March 26, the bank stated that QE had already helped to improve the market conditions for UK debt.

Value of sterling

The value of sterling matters because many of the institutions and individuals who buy this debt are overseas, and so would turn the income they receive from the bond back into the currency they use in their own country.

Weaker sterling thus makes the value of this income fall for overseas investors, and so the attractiveness of buying UK government falls for those investors.

By buying chunks of the debt themselves, the Bank of England ensures all of the debt finds a buyer, and guards against the risk that rate of interest rises materially.

Ms Ward said: “In our view it is the additional quantitative easing in [the] Bank of England package that will have the most significant impact, both in terms of the market reaction, but also a solution to the economic challenges presented by the Covid-19 virus.

"The support to the economy and health system will require vastly higher government borrowing. The central bank showing willing to buy government debt will ensure the market can absorb this additional issuance without undue stress.”

By buying the debt the Bank of England is also providing indirect support for all other asset classes.

This is because, by ensuring that the income an investor can get from a relatively “safe haven” asset like government bonds, it may cause investors who need a higher income to put their cash into other, riskier, areas of the stock market and the economy, in order to get a better return.

CPD
Approx.30min

Please answer the six multiple choice questions below in order to bank your CPD. Multiple attempts are available until all questions are correctly answered.

  1. What is one of the pitfalls of buying bonds when sterling falls?

  2. The Bank of England is buying none of the debt itself, true or false?

  3. Why is QE providing indirect support for other asset classes?

  4. Why is the Bank of England buying corporate bonds?

  5. The investor focus on liquidity has led to a sharp fall in the value of the dollar recently, true or false?

  6. What is stagflation?

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You should now know…

  • Describe the significance of QE
  • Explain the Bank of England's actions towards corporate bonds
  • Describe stagflation

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