People walk and jog past the Bank of England, London June 15, 2012.© Paul Hackett / Reuters/Reuters
The Bank of England signalled on Wednesday that it was close to releasing a wave of new money into the shrinking British economy because of the worsening euro zone debt crisis.
Such a move would effectively involve printing money to buy government bonds, in turn lowering British borrowing costs.
Coming on the back of last week's announcement of new BoE and government measures to spur lending to businesses, it underlines the depth of concern that exists about the state of Britain's economy as its main trading partners weaken.
The first of last week's new lending measures also took effect on Wednesday, when the BoE gave banks £5-billion ($7.86-billion U.S.) of low-interest six-month loans. The banks were urged by the BoE to take the money, sources told Reuters.
Minutes of the BoE's last policy meeting showed officials split 5-4 against launching a new round of monetary stimulus by buying government bonds, significantly with Governor Mervyn King in favour.
A Reuters poll taken after the minutes came out showed that economists now see a 80 per cent chance of another round of QE next month.
The last time the MPC was so divided was in June 2007 – when officials split 5-4 over whether to raise interest rates on the eve of the financial crisis – and the previous time Mr. King was in a minority was August 2009, when he also wanted more QE than the consensus.
The minutes show far stronger support for more stimulus than many economists had expected, and follow the announcement last week of new BoE and government and help Britain's economy, which returned to recession late last year.
They also gel with the mood of other authorities around the world in the face of weaking global growth and massive uncertainty about the euro zone, which combines to rival the United States as the largest economy in the world.
The U.S. Federal Reserve is under pressure to authorize more stimulus later on Wednesday at the end of a two-day policy meeting, while the People's Bank of China cut interest rates two weeks ago in a surprise move.
The BoE's Monetary Policy Committee said the global economy was slowing and that risks to Britain and the rest of the world from financial distress and political tension in the euro zone had intensified.
""Most members judged that some further economic stimulus was either warranted immediately or would probably become warranted in order to meet the inflation target," minutes of the June 6-7 meeting said.
British sovereign bonds outperformed German government debt after the news, as markets bet the bank would soon restart its programme of quantitative easing.
QE, as it is known, is designed to help the economy by making borrowing cheaper and has already led to £325-billion of British government bond purchases.
"The vote in June was much closer than many had been expecting," said Citi economist Michael Saunders. "It's clear the MPC are heading for further QE soon in large scale and I think it's highly important that the governor has switched his vote on that."
The BoE called a halt to new gilt purchases in May, largely because inflation was proving slower than forecast in falling back to its 2-per-cent target.
But this month the BoE said inflation was now likely to be lower than forecast, in part because of falls in oil prices and less generous wage deals as well as risks from the euro zone. Since the MPC meeting, inflation dropped unexpectedly to 2.8 per cent from 3 per cent.
Last month external BoE member David Miles was the only official to call for an expansion of QE, but this month he was joined by King and external member Adam Posen in urging an extra £50-billion of purchases.
Paul Fisher, the BoE's executive director for markets, supported a £25-billion increase.
BoE policymaker Ben Broadbent – one of the five to oppose more QE this month – told Reuters in an interview that the case for more QE had increased, but that he would want to look at the impact of new BoE and government schemes to boost credit before agreeing to more gilt purchases.
Despite the closeness of the vote, some economists said it would be wrong to see more QE next month as a done deal.
"The immediate reaction on the minutes when you see a 5-4 is QE is imminent, and they are flagging it coming. But I don't think it is entirely as black and white as that," said Scotiabank economist Alan Clarke.
In the minutes, some MPC members had said they wanted to see the outcomes of Greek and French elections before deciding on more QE. Both took place last weekend, and Greece appears to have formed a government that broadly supports the country's existing bailout.
The government's options to stimulate the economy are limited due to its commitment to eliminate most of Britain's big budget deficit over the next five years – putting much of the onus on the BoE.
Demand for the 5-billion pounds lent on Wednesday appeared muted as the BoE had to lend some of the funds at the minimum 25 basis point premium over its 0.5 per cent Bank Rate that it was willing to accept.
Anthony O'Brien, strategist at Morgan Stanley, said the result suggested that "the need for liquidity is not as bad as possibly people thought it might be", and that the terms on which the BoE accepted lower-grade collateral were relatively unattractive.
The BoE asked big banks to participate in the operation, in order to remove any stigma attached to taking what could be seen as emergency cash, several people familiar with the matter said.