(BN) BOE Extends Bond Purchases After Recession Deepened (Update2)

By Jennifer Ryan
Aug. 6 (Bloomberg) -- The Bank of England expanded its bond purchase program beyond its original limit in an effort to spur lending and fight a recession that’s deeper than previously anticipated.
Bond yields plunged after the nine-member Monetary Policy Committee, led by Governor Mervyn King, kept the key interest rate at 0.5 percent and said it will increase its purchase program to 175 billion pounds. Twenty-three of 44 economists in a Bloomberg News survey predicted an expansion of the plan, and the rest saw no further purchases.
The bank’s move suggests policy makers, who based the decision on quarterly forecasts prepared this month, assessed that their stimulus plan and record low interest rates weren’t enough to quell the threat of deflation. While services grew at the fastest pace in 1 1/2 years in July, unemployment is rising and banks have kept restricting access to credit.
"These are exceptional amounts of money being pumped into the economy," said Nick Kounis, an economist at Fortis Bank Nederland Holding NV and a former U.K. Treasury official.
"Their forecasts are probably worse then we thought, at least for inflation."
Bond yields dropped and the pound fell after the Bank of England’s statement. The yield on the benchmark 10-year gilt fell 14 basis points to 3.68 percent and the pound declined as much as 0.9 percent and traded at $1.6855 as of 1:05 p.m. today in London.

Bank’s Statement

"In the United Kingdom, the recession appears to have been deeper than previously thought," the central bank said in a statement in London today. "While some recovery in output growth is in prospect, the margin of spare capacity in the economy is likely to continue to grow for some while yet, bearing down on inflation in the medium term."
All 60 economists in a Bloomberg News survey predicted the interest rate would stay at a record low today. The European Central Bank kept its rate at 1 percent in Frankfurt today, in line with the forecasts of all 52 economists in a Bloomberg survey. The Federal Reserve has left its key rate at a range of zero to 0.25 percent since December.
Chancellor of the Exchequer Alistair Darling authorized the Bank of England’s expanded purchases, reflecting Prime Minister Gordon Brown’s concern that the economy remains fragile.
Brown said on July 22 that the bank’s so-called quantitative easing policy and interest-rate cuts have "made a difference." He faces elections by June 2010, and his Labour Party trailed the Conservative opposition by 14 percentage points in a YouGov Plc opinion poll that ended July 30.
"I agree that an increase in the ceiling would provide the MPC with scope to vary the stance of monetary policy to meet the inflation target," Darling wrote in a letter to the central bank.

Bank’s Expansion

Further clues on the central bank’s next move and its assessment of the economy may follow on Aug. 12, when King presents the new forecasts prepared by his staff.
Former policy maker Charles Goodhart told Bloomberg Television yesterday that he favored an expansion of the bank’s purchase program.
"The economy is still fragile, monetary figures are still very low, bank lending hasn’t increased yet and quantitative easing has the great advantage that it can be reversed very quickly," Goodhart said yesterday. "We don’t lose anything if we continue, and we might gain."

Money and Lending

A measure of money supply watched by the bank to assess quantitative easing, known as M4 excluding intermediate financial companies, grew at an annualized rate of 3.7 percent in the second quarter, compared with 6.4 percent for the same period in 2008. Mortgage approvals reached a 14-month high in June of 47,584. That’s a third lower than at the start of 2008.
Unemployment, which reached the highest since 1995 in the quarter through May, may rise further as the economic slump prompts companies to cut staff. GKN Plc, the U.K. maker of car parts for Bayerische Motoren Werke AG, and aircraft components for Airbus SAS, said Aug. 4 that it will cut 1,100 more jobs in the next 12 months.
"It’s not enough, I think they need to do more," John Greenwood, chief international economist at Invesco Asset Management, said on Bloomberg Television. "In the shadow monetary policy committee I’ve been voting for a further 150 billion and to stretch that out to year end."

Strength in Services

An index of services rose this month to the highest since February 2008, and a gauge of manufacturing showed the first expansion this year, Markit Group Ltd. said this week. A report by Lloyds’s Halifax division showed house prices jumped almost twice as much as economists forecast last month.
Lloyds Banking Group Plc, which is 43 percent owned by the government, said yesterday it lost 3.1 billion pounds in the first half and won’t renew about 200 billion pounds of higher- risk loans as they come due over the next five years.
Barclays Plc, the U.K.’s second-biggest lender, said on Aug. 3 that first-half earnings rose 10 percent as profit from investment banking almost doubled. Aviva Plc, Britain’s second- largest insurer by market value, said today that it swung to a first-half profit as margins on the sale of life insurance policies increased.
If policy makers choose in future to expand the purchase program further, the central bank would expect Darling to allow them to do so by "a reasonable amount," Deputy Governor Charles Bean told the BBC in an interview last month.