Bank faces tough call on QE expansion

 

Bank of England policymakers face an unusually tough decision this week: whether to expand the 175 billion pound asset purchase programme at a time when Britain is showing signs of recovery but remains stuck in recession.

Two-thirds of analysts in a Reuters poll reckon the central bank will decide to expand its quantitative easing (QE) programme, with opinion evenly split between a 25 billion pound and 50 billion pound increase.

Following is a summary of possible scenarios for the BoE's decision, which will be announced at midday on Thursday.

BOE UPS QE BY 25 BLN STG, HOLDS INTEREST RATES AT 0.5 PCT

Policymakers noted the "substantial" impact of their QE programme on asset prices, and may view a smaller expansion of the scheme and a slower pace of purchases as a way of providing support to the economy as it emerges from recession.

* Probability: joint front-runner

* Market impact: Gilt prices could sell off modestly, driving the yield on 10-year gilts up around 5-10 basis points on the day, on disappointment that a bigger extension was not delivered. Yields are seen correcting by 30-40 basis points thereafter on the perception the central bank is winding down its asset-buying programme.

BOE UPS QE BY 50 BLN STG, HOLDS RATES 

A shock 0.4 percent contraction in GDP in the third quarter may have persuaded policymakers they need to inject more stimulus into the economy to bring it back on track for growth. The central bank's August projections had pencilled in a modest expansion for the quarter and although rate-setters have warned the road to recovery may be long and bumpy, they may be minded to err on the side of caution.

* Probability: joint front-runner

* Market impact: Gilts would rally, pushing down the yield on 10-year gilts by as much as 10 basis points. However, much depends on how the market reacts to around 7 billion pounds of supply this week and the closely-watched CIPS/Markit services PMI, due on Wednesday.

BOE PAUSES QE, HOLDS RATES

A rebound in asset prices, recently firm PMI surveys, a slower-than-feared rise in unemployment and a recent improvement in consumer morale have provided encouraging news on the economy and may persuade policymakers they have done enough to stimulate growth.

BoE Chief Economist Spencer Dale has expressed concern about an unwarranted rise in asset prices as a result of QE and has spoken of the challenge in unwinding the programme.

Moreover, minutes to last month's meeting omitted any mention that Governor Mervyn King and David Miles - who had wanted a top-up to 200 billion pounds in August and still felt their call was justified in September - remained committed to that view, causing a sell-off in gilts.

* Probability: Around 25 percent