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UK Chancellor Opens Door to Quantitative Easing

The UK Chancellor, George Osborne, appeared to clear the path for a second round of quantitative easing (QE) over the weekend, telling journalists at the G7 meeting in Marseilles, France, that he saw no barriers to such an action, if the Bank of England asked for it.

Chancellor of the Exchequer George Osborne holds Disraeli's original budget box as he leaves 11 Downing Street for Parliament.
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Chancellor of the Exchequer George Osborne holds Disraeli's original budget box as he leaves 11 Downing Street for Parliament.

The UK economy is struggling to sustain its meager economic growth after emerging from a 2008-2009 recession that saw the economy contract by 5 percent. Forecasts for 2011 have been downgraded twice, with the Bank of England currently predicting that GDP will increase by 1.4 percent this year.

With the European sovereign debt crisis still rumbling on unresolved and the global macroeconomic picture remaining increasingly uncertain, the pressures on the British economy remain negative.

The Organization for Economic Cooperation and Development's composite leading indicators (CLIs), released on Monday, show a continuing slowdown in the UK economy.

Adam Posen, a member of the Bank's Monetary Policy Committee (MPC), has been outspoken about what he sees as the need for more QE. Whether more members come around to his point of view will determine whether further capital injection happens this autumn. More weak data could push them into agreement, analysts believe.

As Howard Archer, chief UK economist at IHS Global Insight, wrote in a note to clients on Monday, "For now at least, the Bank of England has held fire on quantitative easing. Evidently, most MPC members maintain the view that further QE is not warranted yet, particularly given current elevated inflation levels and still-significant upside inflation risks.

"However, unless the economy shows signs of picking up soon and global financial market conditions stabilize, the pressure for Bank of England action will mount and it could very well pull the QE trigger within the next few months," Archer said.

IHS's September forecast puts UK growth at just 1 percent in 2011.

The Institute of Directors (IoD), a business lobby group, last week called for a 50 billion pound ($79 billion) extension to QE.

"The time to launch QE2 has arrived," IoD Chief Economist Graeme Leach said. "The downside economic risks are sufficiently great to warrant an extension in quantitative easing now, in order to avoid the risk of a double-dip recession. We already have an L-shaped economic recovery and the hit to business and consumer confidence over the summer risks a slip back into recession, which could have dire fiscal consequences. Expanding QE by 50 billion pounds initially is a sensible and limited response."

Others, including economist George Buckley at Deutsche Bank, believe that while the risks to the UK are strongly to the downside, they are unlikely to be severe enough to prompt a second program.

Research published by Deutsche on Monday suggests that the first round of QE did have an affect on the UK economy, reducing gilt yields on maturities bought by the bank by 70 basis points and increasing the money supply to the economy. During the first round of QE, corporates were able to increase their borrowing from the financial markets, Deutsche found.

However, Buckley wrote, third-quarter GDP growth may show that the UK has shrugged off the temporary drags of the Japanese earthquake and the royal wedding -- those "special factors" shaved 0.5 percent off growth in the second quarter, according to the Office for National Statistics.

Furthermore, Buckley noted, a law of diminishing returns may be in effect, reducing the potential upside of a second round of QE. The effect of such a program on consumption, currently very weak in the UK, is also doubtful. Finally, he said, the monetary stimulus that the bank has provided through its dramatic rate cut during the crisis, and its decision to hold rates at 0.5 percent, call into question the need for another stimulus.

Osborne appears to be inflexible on government cuts and is unlikely to reign in his targets in order to provide a temporary respite to the economy.

The chancellor remains under pressure, not only because of recent revelations about his private life. Youth unemployment, widely thought to be a root cause of the violent riots that shook several British cities in August, remains high, and households are only just beginning to feel the pinch from the government's austerity measures.

The UK's recession will "cast a long shadow" over living standards, which look likely to decline until 2013-14, according to a new report from the Institute of Fiscal Studies (IFS), an influential think tank.

State support and welfare systems initially cushioned the blow of the recession for many households, the IFS said, but "the pain was most definitely delayed, rather than avoided," according to the report. With the government now cutting back spending, and with benefits, tax credits and earnings all falling back in real terms in 2010-11, the think tank said that the country has experienced "one of the worst decades for changes in living standards since at least the Second World War."