Investments  

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

This boosts the value of equities and corporate bonds at a time when market sentiment towards those asset classes is otherwise very weak as investors flee uncertainty.

Fahad Kamal, chief market strategist at Kleinwort Hambros said QE has already achieved the aim of allowing governments to borrow at a cheaper rate.

He says: "Government bond markets.. have stabilised somewhat as yields have come down from mid-March highs.

"Essentially, QE definitely has helped with liquidity – and in lowering borrowing costs – but it is not a salve to the economic sudden stops that are occurring right now.

"Beyond QE, it will require a combination of a slowdown in viral transmission, better news on treatments (or a cure) and huge fiscal stimulus demonstrably mitigating the destruction that is occurring to aggregate demand."

Justin Onuekwusi, fund manager and head of retail multi-asset investing at Legal & General, agreed the cash injection provided by the Bank of England also serves to help the whole of financial markets.

He said that pumping cash into the system reduces the extent to which investors worry about the liquidity of markets in general, and this reduces the incentive to sell assets and hold cash, and so acts as a support for asset prices. 

The investor fixation with liquidity led to a sharp rise in the value of the dollar in recent weeks. The dollar is the most liquid asset in the world, so investors have been eager to hold it.

Mr Onuekwusi said by increasing the volume of sterling in the system, the liquidity of the pound increases, and this may make it strengthen relative to the dollar.

That would boost the attractiveness of UK government bonds to overseas investors, and also mean that investors have less reason to sell off sterling assets, boosting the stock and bond markets.

Banking system

Additional cash in the system is likely, directly or indirectly, to find its way into the banking system. Banks can then use this cash to lend more into the real economy, or shore up their books if they are suffering heavy losses as a result of businesses going bust. 

Some of the extra £200bn being put into the market by the Bank of England is being spent on buying corporate bonds, that is, the debt of private companies. 

The aim is to ensure that those private companies can continue to finance their operations by borrowing from the markets.

If the central bank did not buy corporate bonds then the yields would rise sharply, and companies would find it less affordable to source credit, which would restrict their capacity to stay in business, and employ people. 

CPD
Approx.30min

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