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Bank of England Faces Tough Decision on Stimulus

The Bank of England's injection of 175 billion pounds ($289 billion) into the economy hasn't yet pulled Britain out of recession, and the central bank now faces a difficult decision on whether to raise the stakes.

The bank's monetary policy committee began its monthly two-day meeting on Wednesday, a day before it announces its latest decision on interest rates and quantitative easing, its strategy of stimulating the economy by inflating the money supply.

Markets are waiting to see if the amount will be increased, and if so, by how much. Some think the bank could add 25 billion pounds or more.

"The decision appears finely balanced, although expectations are tilted towards an extension," said Simon Hayes at Barclays Capital.

The decision comes two weeks after disappointing news that U.K. gross domestic product, or economic output, fell by 0.4 percent in the third quarter, contrary to expectations that the economy would move into growth.

The key interest rate is expected to stay at a record low of 0.5 percent for the eighth consecutive month, but the market has been left guessing about the Bank's next move on monetary easing.

Sharon Lorimer

The bank buys securities from banks, giving them ready cash, and credits their account at the bank, in effect creating new money.

Boosting the money supply is done during serious downturns in hopes it will get credit flowing to businesses so they can operate and expand. It has to be withdrawn as growth returns to avoid causing inflation.

"While a lot of uncertainty surrounds the accuracy of the preliminary national accounts data ... we believe that the GDP fall tips the odds in favor of the Bank of England extending QE by at least a further 25 billion pounds," said Howard Archer, chief European economist at IHS Global Insight.

"The case for more stimulus in the U.K. will be strengthened by signs that the 175 billion of asset purchases are still not getting much 'bang for the buck' when it comes to credit growth or the money supply more generally," said Andrew McLaughlin, chief economist at Royal Bank of Scotland.

The issue for the MPC, however, is whether recovery is coming, even if not as strongly as hoped, in which case no further stimulus would be needed. There have been some positive signs.

House prices are rising again, and so are mortgage approvals; retail sales are up and consumers are more confident.

On Tuesday, Lloyds Banking Group confirmed that conditions have improved enough for it to do without government insurance on any toxic assets, even if it needs another 5.7 billion pounds from the Treasury — part of a project to raise 21 billion pounds — to shore up its balance sheet.

Winterizing Your Portfolio - A CNBC Special Report
Winterizing Your Portfolio - A CNBC Special Report

But Lloyds is still losing money, and that's the flip side of much of the recent "good" news.

Many indicators look good only in comparison to the depths of the recession earlier this year.

Unemployment is expected to grow, and some analysts fear a W-shaped recession.

Minutes of the MPC's October meeting, when it decided to stand pat on quantitative easing, revealed that there were differences among the nine members on what to do next.

The minutes indicated committee thought the program had helped boost prices for stocks and bonds, despite criticism from some economists that banks were simply holding on to the funds to boost their own balance sheets rather than expand lending.

Contact Europe: Economy

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