Critically explain how Quantitative Easing (QE) by the Bank of England in recent years, via open market operations in the money markets, has impacted bond and stock, prices including housing prices in the capital markets in the United Kingdom.

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Critically explain how Quantitative Easing (QE) by the Bank of England in recent years, via open market operations in the money markets, has impacted bond and stock, prices including housing prices in the capital markets in the United Kingdom.

1.b. Critically explain how Quantitative Easing (QE) by the Bank of England in recent years, via open market operations in the money markets, has impacted bond and stock, prices including housing prices in the capital markets in the United Kingdom. (Please include recent financial charts and tables to support your analysis)

More or less 600 words for this question.

Notes:

The question requires you to: explain critically, the impact of the Bank of England’s Quantitative Easing on prices of bonds and stocks and housing within the United Kingdom’s financial markets (capital markets and money markets).

✓ Please note that the requirement of the question is about Quantitative Easing by the Bank of England and in the United Kingdom.

✓ Please note that the question is about the Quantitative Easing in the Bank of England and with the UK’s financial markets.

✓ Please avoid discussions outside the Bank of England and the United Kingdom’s money and capital markets.

✓ Please note that the question requests you to illustrate your analysis with financial charts and tables in order to earn good marks.

Quantitative easing is an unconventional monetary policy strategy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply.

Quantitative easing is a monetary policy action whereby a central bank purchases predetermined amounts of government bonds or other financial assets in order to inject money into the economy to expand economic activity.

In the words of the Bank of England, quantitative easing is when the Bank buys bonds to lower the interest rates on savings and loans. That helps the Bank of England to keep inflation low and stable.

➢ It increases the money supply by flooding financial institutions with capital in an effort to promote

increased lending and liquidity.

➢ It is considered when short-term interest rates are at or approaching zero, and does not involve the

printing of new banknotes.

It involves Central Bank increasing the money supply, using electronically created funds to buy government bonds or other securities.

These are not purchased directly from the government but from other parties such as banks, insurance companies and pension funds in the secondary market.

QE therefore provides these financial companies with extra money.

The Central Bank (BOE) expects this to boost the economy via a variety of different channels:

Aims of Quantitative Easing:

➢ Increase bank liquidity:

✓ when commercial banks sell bonds to the Central Bank, they have an increase in their cash reserves.

✓ this increase in cash deposits should, in theory, encourage commercial banks to lend to businesses.

➢ Increase in market price of bond:

✓ this happens through the purchases of government bonds; it leads to a reduction in long term interest

rates.

✓ lower interest rates should encourage greater economic activity in the economy.

How Quantitative Easing Works:

QE essentially involves a central bank creating new money and using it to buy existing financial assets, usually government bonds (debt issued by the government).
The central bank creates money electronically.
This is similar effect to printing money, except they are increasing bank reserves which don’t need to be printed in the form of cash.
The Central Bank uses these extra reserves to buy various securities.
These include government bond and corporate bonds.
This extra demand for bonds drives up the price, thereby lowering the bonds’ yield (or rate of interest you receive on the bond).
The yield on government bonds is a key benchmark for other interest rates in the economy.
As a result, lowering the government bond yield lowers interest rates across the economy.
This incentivizes businesses to invest and take on more risks, as well as consumers to spend more, boosting economic growth.

So, quantitative easing is about money printing?

In a roundabout way, yes.
The central bank injects new money into the economy to spur growth.
However, it is important to note that the central bank is making its purchases on the secondary market and not directly providing the money to the Government.

Buying these securities achieves two things:

Banks sell assets (bonds) for cash.

➢ Therefore, banks see an increase in their liquidity (cash reserves).

➢ In theory, the bank will then be more willing to lend to customers.

➢ This lending will be important for increasing investment and consumer spending.

Buying assets reduces their interest rate.

➢ Lower interest rates on these securities may also encourage banks to lend rather than keep securities

which are paying low interest.

➢ Higher lending should help improve economic growth.

Channels through which QE Works:

Increases asset in prices, provides a ‘wealth effect’ to firms and consumers as their assets increase in value, this potentially leads them to spend more
Reduces borrowing costs by driving down interest rates on gilts (increased demand for gilts, pushes up their price, which reduces their yield, or interest, on them)

iii. As interest rates on gilts fall, financial institutions buy other assets like shares (which would increase

wealth) or corporate debt (which would reduce borrowing costs for companies); this is also known as the portfolio balancing channel

Increased lending from banks to companies and households (increasing incomes and spending in the economy).

Problems with the QE:

Central Bank creating money out of thin air with very little additional assets to support.
This could potentially lead to high inflationary pressures.
Future borrowing by the banks/government via issues of bonds might be difficult in the future.
There may have been many sellers of gilts but there may not be many willing buyers when the bank wants to sell its holdings.
Significant adverse effect on savers and pensioners.

Quantitative Easing in Practice in the United Kingdom:

QE is used to stimulate an economy near recession, that when there is successive fall in output (GDP), unemployment, rising inflation, and low level of banking sector lending.
This was the situation in the UK during 2009 (still is the current problem).
In the UK, to stimulate the economy, Bank of England electronically created £200 billion in 2009 via QE operations.
The Bank of England uses the Money Market to buy back UK government assets, mainly low risk government bonds/gilts from the commercial banks, insurance companies, pension funds and other companies.
The Bank of England calls this the asset purchase scheme.
Note the purchase back mainly has involved the most risk free asset available –The GILTS.

✓ Gilts are bonds that are issued by the British government

✓ Gilts are fixed-interest loan securities issued by the UK government, generally considered low-risk investments.

✓ Gilts are the U.K. equivalent of U.S. Treasury securities, and the name originates from the original certificates, issued by the British government, which had gilded edges.

https://www.bankofengland.co.uk/monetary-policy/quantitative-easing

https://www.youtube.com/watch?v=J9wRq6C2fgo