BoE surprises by announcing QE2 ECB leaves rates on hold but restarts liquidity measures

The FTSE 100 closed strongly higher by 3.7% on a day when the Bank of England announced a second phase of quantitative easing and the ECB reintroduced measures to shore up bank liquidity.

Strong gains were seen in the banking and insurance sectors, which had already been boosted by increased trader optimism that eurozone states would continue to support bank liquidity should there be any shortfalls. The FTSE 350 banking and insurance sectors rallied 6.5% and 8% respectively, providing much of the energy behind the FTSE’s gains. Similar gains were seen in mining stocks too, which closely tracked a 4% jump in the price of copper.

BOE becomes proactive
The Bank of England announced a second phase of quantitative easing today in a move that surprised most in the market. The BoE held rates on hold but increased asset purchases by £75 billion to £275 billion in an effort to boost anaemic growth in the UK.

Many had expected no change in stance on stimulus until potentially next month when the BoE would have the chance to digest the quarterly inflation report.

The move by the Bank of England is a stark contrast to the ECB, which held rates at 1.5% today when many in the market had been calling the European Central Bank to cut rates. The ECB did however announce, to some degree of expectation, a reintroduction of 12-month and 13-month LTRO (longer term refinancing operations) to help increase bank liquidity, whilst also announcing the planned purchase of €40 billion worth of covered bonds.

It’s an aggressive move by the Bank of England, which has clearly taken a more proactive step to curtail the UK from potentially slipping into a double dip recession. The UK Central Bank has often been criticised for being too reactive and not proactive enough and certainly today’s move to effectively announce QE2 at a time much earlier than many had expected flies in the face of that criticism.

The size itself is also significant, slightly more than many had anticipated was likely to happen next month, and the MPC statement that the scale of the programme will be kept under review allows for the scale to be increased in size over time.

Starting QE2 typically creates upward pressures on inflation and so today’s move is a risky one, though certainly with the MPC expecting inflation to hit 5% but then fall back below the 2% target in the medium term, this forecast has certainly freed their hands somewhat.

The impact of today’s measures saw an immediate fall in value of the pound against a basket of currencies. The pound fell 1% against the US dollar on the back of the announcement before recovering some of its losses into the evening.