Is quantitative easing still the answer?Posted on: 10 November 2009 by Mark O'haire
Independent financial advisor Peter McGahan discusses the merits of introducing a further £15 billion in quantitative easing.
Ideally it would have been preferable for no more capital injection to be required. As all this capital makes its way into the system, confidence rises and the tail of the whip becomes more and more likely to be inflation. That inflation is harder to control as the Bank of England cannot simply sell its gilts back or increase interest rates.
However, in behind all the potential for quantitative easing to create inflation are a range of deflationary pressures that are dampening any thought of hyper inflation.
Whether it’s the threat of employment levels falling (which in turn takes the UK’s wages with it), or public sector wage threats, all of this makes its way through to less buying power and lower prices.
Other deflationary pressures include a look at most major recessions since the late 1960’s where core inflation fell on average by almost 4% over the two years following the trough of a recession. Ireland is currently ‘enjoying’ core inflation of -2.2% and Spain nearby. It is therefore no surprise that this has made its way through to salaries and in the UK earnings growth has been the slowest since records began.
On the flip side, emerging economies are using many more resources and this is also making its way through to prices. A weakened sterling has also increased the prices of imports although if inflation and recovery is back in the system, you might expect sterling to recover, making those same imports cheaper.
The Bank of England has just announced it would increase its quantitative easing plan by another £25b. The market responded positively to that and sterling appreciated as they were expecting £50b.
The fact the UK failed to exit recession in the third quarter will have motivated the monetary policy committee to extend quantitative easing even though there has been strong signs of positive activity form private business surveys and a house price pick up.
Personally I notice that there are more people in pubs! This is my cruder, but most accurate measure of an economy!
The Bank of England report published later this week will give a better insight into their thought process. The monetary policy committee have been particularly concerned that as households use lower interest rates to lower their debt and banks continue to self paralyse, that once interest rates rise, we could easily see the normal double dip in the economy.
My view has not changed since before we went into this recession. In October 2008 I highlighted inflation not to be a problem and said rates would plummet. I highlighted the motivation that it takes eighteen months for these changes to fully make their way into the system and that November 2008 was a key date – its eighteen months before an election.
This confidence is making its way through to the system already and the ‘support’ of the housing market will easily maintain buoyancy in confidence.
However, the support of the housing market will be short lived and with the inevitable interest rate rises, house prices will be dampened again by mid 2010 and will probably remain flat for some two to four years.
If inflation then comes into the system, investors will probably enjoy higher interest rates coupled with higher equity prices which make the property investment a less attractive return for the risk.
At the same time homeowners will now face the reality of higher costs after the current emergency rates have been lifted. It’s difficult to see how any of that can be positive for property in the short term.
Personally, I have a very strong feeling the next economic report will show we are indeed out of a recession and the economy and markets will be strong until the new government whoever they may be sits down with the task of rebalancing the books.
The next winter could then be an interesting one.
By Peter McGahan
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Peter McGahan is an Independent Financial Adviser and Managing Director of Worldwide Financial Planning. Worldwide has won 16 Financial Times awards in the last four years. Peter has also been named the top media IFA of the year by Unbiased.co.uk in 2009.
Peter comments regularly in major journals such as the Mail on Sunday, Irish News and Sunday Times and is a weekly columnist for FT Adviser. He has also appeared on Working Lunch and the Today programme. In addition he is an expert on international tax matters for a range of international publications.
Worldwide Financial Planning Ltd are authorised and regulated by the Financial Services Authority. 'The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.'
Information given is for general guidance only, and specific advice should be taken before acting on any suggestions made. The above represents the personal opinions of Peter McGahan. All information is based on understanding of current tax practices, which are subject to change. The value of shares and investments can go down as well as up.
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