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Central bank bulletin: what, why and where

Within less than 24 hours of each other, the European Central Bank (ECB) and the Bank of England (BoE) have announced they will inject similar amounts of cash into the economy –around 9% of their respective GDPs. Hetal Mehta, Senior European Economist, looks at what it means when central banks go “all in”.

The absence of a quantitative easing (QE) announcement from the BoE until yesterday in this crisis was notable and the gilt market had reacted with a sharp rise in yields in recent days. But as authorities become alert to the severity of the situation and the nature of the containment measures, which will effectively curtail economic activity, the central bank has been spurred into action, mirroring the similar increase in responses from central banks that we have witnessed this week.

The BoE announced an expansion of its Term Funding Scheme with the purchase of £200 billion of sovereign and corporate bonds. When market volatility is so high, a week feels like a long time, and this move comes just eight days after the first round of the co-ordinated monetary and fiscal response. At 0.1%, the BoE has cut interest rates to their effective floor (at least while they hold the view that negative rates would be counterproductive). This expansion of the Term Funding Scheme should help pass on lower rates and to support businesses while they weather the near-term implications of a sharp slowdown in activity. The monetary and fiscal response is not so much intended to stimulate the economy in the traditional sense, as to bridge the gap that a massive demand and supply shock has caused, in order to minimise permanent damage to the country’s economic capacity.

Understanding policy responses and the impact of central bank and government action is crucial. Not all measures will have the same impact, so it is important that we comprehend the effects of such actions on the broader economy, and look at where the alleviation of pressure points is likely to be.

The first priority of governments will be to get the virus under control. But to support that and the daily functioning of people’s lives, policymakers are coming up with a wide range of instruments.

The UK appears so far to have co-ordinated its monetary and fiscal responses, with more government measures apparently in the pipeline to support businesses in continuing to pay their workers while the extraordinary situation persists. In addition to mitigating the short-term impact, the actions taken are intended to help the economy recover more quickly and return to normal once the crisis has abated.

 

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