QE2 - Will the second round of Quantitative Easing sink or float the economy?

Posted on: 17 October 2011 by Nick McBreen

£75billion injection from the Bank of England could hit the retired in the pocket.

£75 billion quantitative easingNot so long ago, if you mentioned QE2, most people would think of a very big ship. Not anymore. QE2 has now come to mean the second round of the Bank of England's Quantitative Easing policy. The Bank announced last week that a further £75billion would be created to stimulate the UK economy. At the same time, they announced that interest rates would be kept at their record low of 0.5%.

The continuing of this period of historically low interest rates is good news for those on tracker or variable rate mortgages. The Council of Mortgage Lenders (CML) reported that this month had also been a record month for remortgages, with many people remortgaging to get a better deal on the interest rate they were paying. According to the CML, the number of people remortgaging increased by 9% in August 2011 compared to July 2011(1). 

But what about Quantitative Easing? Is that good news for borrowers or for savers, or for both? 

It might be useful to have a brief reminder about what the quantitative easing policy actually involves, as various explanations can be found in various places. The first round of Quantitative Easing (or QE) took place in 2009, since then a staggering total of £275billion has been injected into the UK economy. The Quantitative Easing policy is not quite as simple as printing money; what the bank actually does is create money electronically. This money is then used to buy Government bonds, or Gilts as they're usually known, as well as debt from financial institutions such as banks and insurance companies. 

How does that help us? 

What the quantitative easing policy is intended to do is to encourage banks to lend to businesses. If you're cynical, as we are, you'll note the word 'encourage'. By doing that, the theory is that the economy will be encouraged to grow. If businesses have more money, they can grow, employ more staff and make more goods to sell. That's one of the upsides of the policy.

There is also a further upside for those with mortgages, and those intending to take on a mortgage. If the Bank of England buys a lot of long-term Gilts from the banks, it could mean that they re-introduce longer term fixed rate borrowing, with better rates than there are currently on fixed-term deals.

Inevitably, there are downsides to this increase in money. Quantitative easing means that the price of Gilts increases. In turn, this means that the yield they provide (the income they give to holders of Gilts) drops. This has a particularly negative impact on investments, such as pension funds, that hold Gilt funds which people rely on for income. 

Pensions are also further affected because of the way the yield on Gilts is linked to the yield on annuities. The reason for this is that in the past, insurers used investment in Gilts to give people buying an annuity, a secure income. If the income from Gilts falls, so, too, do annuity rates. Bad news for those coming up to retirement.

The other downside of Quantitative Easing is that it has the potential to increase inflation. In the case of debt, inflation is not a bad thing (particularly for the government), because it reduces the value of the debt. What inflation also does, however, is reduce the value of every pound in our pockets, meaning we're able to buy less. 

Whether you are a saver or a borrower, or both, now is a good time to take action to help your finances. If you have a mortgage, talk to an independent broker to make sure you are getting the very best deal you can on interest rates. An independent mortgage broker will be able to search you out the best deal. 

If you are a saver or have a pension fund, talk to your independent financial adviser for a review of your savings and investments, to make sure your money is in the best place. If you are retiring now or in the near future, a good independent financial adviser will talk you through all your options. With annuity rates falling, you want to make sure your income is the best you can get, so you can enjoy your hard-earned retirement.

For a free financial review, call Worldwide on 0845 230 9876, e-mail info@wwfp.net or take a look at our website wwfp.net.

Source: (1) Guardian

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