Hi °C | Lo °C The Bank of England has made a leap in the dark and is gambling its latest interest rate cut and the injection of £75 billion in new money into the economy will kick-start lending and spending, a senior economist said today.
Philip McDonagh, of business advisors PricewaterhouseCoopers said the bank had made a leap of faith.
The reduction of interest rates to an historic low of just 0.5% was about as far as they can go in using interest rates to try to regenerate the economy, according to PwC.
The Monetary Policy Committee's new weapon in the battle against the credit crunch - quantitative easing - will see the Bank of England buy up to £75 billion of securities over the next three months.
Frequently, but wrongly described as printing new money, quantitative easing does not boost the amount of money in circulation by freshly minting and printing new coins and notes, said PwC.
Instead, said the businesses advisors, the Bank will buy assets like government securities - gilts - and high quality corporate bonds.
In theory the money it pays for the assets is then available to commercial banks to lend to businesses and consumers.
Mr McDonagh said low base rates, plus quantitative easing, equalled more money in circulation and a real reduction in both short term and long term borrowing.
"Hopefully that will re-inflate bank reserves, increase the flow of lending and instil investment confidence. This is new territory for the Bank of England, but there are some experiences they can draw on," he said.
Japan used quantitative easing in 1990s as a last resort to regenerate its economy and the US was currently pursuing a similar policy of buying back Treasury and corporate debt, he added.
But Mr McDonagh said: "Explaining quantitative easing is difficult enough; making it work will be a real challenge.
"For the Bank of England, this is a real leap of faith - and also a leap in the dark."
PwC said the bank's decision on bank rates would not be welcomed by savers who would now earn virtually nothing and by mortgage lenders who relied on savers' deposits to fund new mortgages.
Meanwhile the Federation of Small Business welcomed the interest rate cut, but said access to finance rather than the cost of it was the main concern for small businesses.
FSB policy chairman Wilfred Mitchell said polls of members suggested recent interest rate cuts - six in almost as many months - were not having the desired effect and other means of economic stimulus were required.
"Small businesses are clearly worried that this monetary policy has been used extensively over the last few months yet they are still struggling to access cheaper finance.
"The concern now is that if rates are cut any further there may not be too much more room for manoeuvre in the economy.
"The onus is really on the banks to start promoting these lower rates to fire up the economy," he said.
The Northern Ireland Independent Retail Trade Association said interest rate cuts were more or less at the end of the road and it was to be hoped quantitative easing would have the right impact on the economy.
Chief executive Glyn Roberts said: "While the repeated interest rate cuts have been helpful to consumers and businesses, we are still not seeing any real recovery in consumer spending."
He said the 2.5% VAT reduction before Christmas had little or no success in encouraging consumer spending.
"We would urge the Chancellor to end the VAT cut and use the intended funds for reducing front line taxes for hard-pressed families and for businesses struggling to survive in this recession."
