BoE May Flood UK Economy With More Bond Buys: Pros

The Bank of England may yet launch another round of quantitative easing (QE), despite the central bank's decision to keep bond purchases on hold on Thursday, market watchers said.

The Bank of England (BoE) announced it had decided to keep interest rates at a record-low of 0.5 percent, holding off on purchasing more Gilts (UK government bonds) — at least for now.

Since January 2008, the BoE has purchased a total of 375 billion pounds ($599 billion) of Gilts in order to reinflate a wilting economy.

"We think that more policy stimulus will be required in the coming months — the question is whether the Committee feels it has the tools to deliver it," wrote Vicky Redwood, chief U.K. economist at research firm Capital Economics, in a note on Thursday.

Market participants said the BoE's decision to keep policy on hold could reflect uncertainty about the economic climate. These analysts say the central bank also wants to ascertain how effective its "Funding for Lending Scheme" is before signaling any halt to quantitative easing, or QE.

The program, launched in July, offers banks and building societies cheap loans if they in turn offer loans to the U.K.'s non-financial sector.

"Many hopes are pinned on the Funding for Lending Scheme, but it will take some months before its impact can be properly assessed," said Chris Williamson, chief economist at financial information firm Markit, in a note.

According to official estimates, the U.K.'s gross domestic product grew by 1 percent in the third quarter, but private surveys suggest the economy may be losing momentum again. Consumer spending dropped sharply in October, and the all-sector Purchasing Managers' Index (PMI) sank below 50, indicating a contraction.

"There is an unusually high degree of uncertainty about economic growth at the moment. The official data been difficult to read, with distortions due to the Queen's Jubilee and the Olympics adding a great deal of volatility to the data," said Williamson.

He added: "The lack of any decision probably not only reflects uncertainty about the health of the economy, but also doubts about the effectiveness of policy, even if more stimulus was considered appropriate."

Despite such concerns, Mike Amey, portfolio manager at fixed income management firm Pimco, said the BoE could recommence Gilt purchases before the end of this year.

"I think they will be back at the QE table in a month or two," Amey told CNBC. "They want to give the Funding for Lending Scheme some time to work, but I do not think it will be the sole answer."

Samuel Tombs, U.K. economist at Capital Economics, predicted the BoE will purchase a further 50 billion pounds ($80 billion) worth of Gilts in the first quarter of 2013, with the possibility of another round of purchases later in the year. His firm also predicts the central bank may cut rates to 0.25 percent.

"I think if the economic data remains as soft as it has, it would be quite easy to let the economy slip back into recession," Tombs said.

The BoE's policymakers may yet pull the trigger on lower interest rates, Capital Economics' Redwood said Thursday, despite lingering doubts about how effective such a move could be.

"Thereafter, the MPC [Monetary Policy Committee] will have to venture into even more unconventional territory — perhaps coinciding with the arrival of the new Governor at the end of next June," Redwood said.

"For example, the Committee could extend the scope of its asset purchases to include private sector assets. Again, the MPC has been cool on this in the past, but it will have to become more open-minded," she added.

Extending the scope of asset purchases could benefit U.K. businesses, according to the British Chambers of Commerce.

"If the MPC agrees to purchase private assets other than gilts, such as securitized SME [small and medium-sized enterprises] loans, banks would be less risk-averse in lending to businesses," wrote David Kern, chief economist at the business lobbying group, in a note Thursday.

Capital Economics predicts the U.K. will grow by just 0.5 percent in 2013, versus the MPC's latest forecast of 2 percent. That could put added pressure on the central bank to do more to support growth.

"There are still numerous constraints on the economy, and the recent business surveys suggest that underlying output is contracting," said Redwood.

— By's Katy Barnato