Latest dose of QE likely to come with nasty side-effects

The key questions now are what impact will this latest effort to resuscitate the economy have, and how will it impact the average man on the street? The Bank of England hopes that QE will lower the cost of debt that individuals and companies pay on their borrowing, which in turn will lead to a pick-up in consumer spending and confidence.

While this is of course desirable, it is not at all clear whether QE helps in the way that the textbooks might suggest. That is because of QE’s key side-effect: inflation. This is likely to be much more prominent this time around as the UK will be alone in using QE as a monetary tool, unlike in 2008/09 when the world’s largest economy, the US, was also hitting the printing presses.

To recap, QE is implemented by creating money out of thin air electronically and buying UK gilts with that money. One of the major holders of gilts is the UK banking system, so the thinking goes that as the Treasury buys bonds, demand outstrips supply and holders of gilts eventually sell to the Treasury.

As the price of gilts rises, the regular income received by holders of gilts falls as a proportion of the price. A component of all lending that is conducted in the UK is ultimately linked to the price of gilts at some point.

The combination of freeing up cash on banks’ balance sheets through the purchase of gilts and lowering the cost of borrowing should reduce the rate of interest charged on loans and increase the availability. It importantly reduces the rate the UK has to pay on its debt, which is no coincidence.

While the logic is fine, the evidence of it working is not overwhelming. Very few people say that dealing with the banks is easy and, if anything, securing a loan is becoming harder. Additionally, the man on the street has had to cope with a sharp increase in the cost of living driven by currency weakness, which in turn has increased the cost of electrical goods and other imports.

A large part of this currency weakness has been driven by QE; if you print money the cost of stuff goes up, and we can expect the pound to weaken further. Given the UK’s dependence on imports, this will once again increase outgoings for the average household at a time when wage growth remains flat. Additionally, property prices are back at 2007 levels, which, if you take into account the increased cost of living represented by inflation, equates to a reduction of more than 20 per cent.

One of the other inadvertent problems with QE is that it punishes savers at the expense of the “debt junkies” who have borrowed too much (including the government). This is evidenced by inflation running at the current level of 4.5 per cent (and expected to top 5 per cent in the coming months before the year-on-year impact of the VAT hike starts to moderate) while even the best bank deposit rates are generally well below 2 per cent.

The big issue now for the UK relates to competitiveness at a global level. The artificially high level of the pound in the late 1990s and 2000s led the economy to shift away from exports to financial services and also led to an increased dependence on imports. The UK economy needs to be rebalanced and bureaucracy and red tape reduced before we can have a sustainable recovery.

In summary, it is questionable that this latest round of QE will work any better than the first. What is really needed is direct support and a stability mechanism for consumers and small and medium enterprises (SMEs).

If SMEs have confidence that they can fund daily working capital requirements and that the banks will be supportive of this, it will lead to improved confidence and likely to a reduction in the unemployment rate, now at its highest level since 1994. A confident consumer is in turn likely to spend and borrow more.

The Bank of England acknowledges there is a need for additional support, but I suspect the latest round of QE is unlikely to have the desired effect.

• Haig Bathgate is chief investment officer at Turcan Connell