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Bank of England mulls 'nuclear option' of cash injection

Section: Daily Dispatches

By Edmund Conway
The Telegraph, London
Friday, December 5, 2008

The Bank of England is working on radical plans to inject cash directly into the economy -- the nuclear option to be used only when interest rates approach zero.

In what would be a major departure for British monetary policy, the Bank is considering pressing the button on printing presses by engaging in a so-called policy of quantitative easing. It emerged after the Monetary Policy Committee cut borrowing costs by 1 percent to just 2 percent -- the lowest level since 1951.

In the statement published alongside its decision, the Bank warned that "it was unlikely that a normal volume of [bank] lending would be restored without further measures."

The measures under consideration include direct purchases of assets, such as government debt or commercial investments, by the Bank or the Treasury, as well as expanding the Bank's balance sheet, a means of pumping extra cash into the banking sector.

The radical proposals, which are currently being explored by Bank experts, could be put into action within weeks, although they would have to be vetted by the Treasury, which is thought to remain sceptical. The main obstacle is that the policy could be found to conflict with European Union laws on how governments manage their budgets.

However, added weight was given to the proposals by European Central Bank President Jean-Claude Trichet, who seemed to hint in the press conference to announce the ECB's 75 basis point rate cut yesterday that it may also consider "nuclear options."

"We will look at what is necessary at any period of time," he said. "If new decisions are needed, we will take new decisions."

If the plans do go ahead it would be the first time since the 1970s that the Bank of England has effectively attempted to target the volume of cash in the economy, by using its balance sheet, rather than the price of money through interest rates.

The news underlines the fact that despite having slashed rates from 5 percent this year, and put around L500 billion of money behind schemes aimed at kick-starting the mortgage lending market, it has failed to arrest the financial crisis.

Danny Gabay of Fathom Consulting said: "There has been a seismic shift at the Bank of England. I think [quantitative easing] is a natural progression from where we've got to now. The Bank has reached a tipping-point with interest rates. With a target rate for inflation of 2 percent, this cut means that real interest rates are now at zero.

"It's quite sensible for them to start thinking about what other things to do. The easiest thing that they could do is to under-fund the fiscal deficit."

This would involve using the Ways and Means bank account at the Bank to buy government securities and would, in effect, amount to printing cash. In normal times such a move would be highly inflationary, but with the UK facing deflation next year such a plan is now thought to be valid.

A number of other central banks, including the Riksbank in Sweden, the Danish central bank, and the Reserve Bank of New Zealand also slashed rates as the global economic slowdown took hold.

With experts speculating that the MPC might contemplate another 1.5 percent cut, the pound dropped sharply ahead of the decision, but it later recovered to close down 1.32 cents at $1.4690 against the dollar.

Halifax reported that house prices dropped by 2.6 percent in November alone, while the Society of Motor Manufacturers and Traders announced that new car sales plummeted at the fastest rate since 1980. The total number of new car registrations last month was 100,333 -- down 36.8 percent on last year's level.

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