After quantitative easing

Charities must examine the economic environment now, says John Hildebrand of Rensburg Sheppards

The Government has spent £171bn of the £175bn it allocated to quantitative easing. So the obvious question is: what happens now?

According to the Bank of England's report on QE, the Monetary Policy Committee authorises the Bank of England to buy bonds from private sector institutions, which leads to sellers having more money in their bank accounts and so makes banks more willing to lend. The aim of this is to ease credit conditions and reduce the cost of finance for companies. Credit conditions have so far eased, so the policy has had some success.

The same report says that when credit conditions ease and inflation starts picking up, the idea is that the Bank of England reverses policy at just the right time and keeps inflation in check by selling gilts to mop up surplus money; but the danger is that the markets take control and push up interest rates beyond where they need to go.

The first risk is that all the benefits are reversed; the second is that the increase in the money supply leads to higher inflation and the need for higher interest rates. The third worry is that investors become concerned about deteriorating public finances and so sell UK bonds and UK assets, particularly sterling.

This all presupposes that the MPC does not increase the amount of money it has allocated to QE. According to a recent Reuters poll, 43 out of 62 economists think the MPC will extend QE. But even if it does, it still seems likely that QE will end soon.

So what does this mean for charities? Interest rates are very likely to rise in 2010. The amount they go up will depend on the strength of the economy, but the willingness of National Savings and Investments to issue one-year guaranteed growth bonds at 3.95 per cent suggests there are some people in government who see interest rates heading towards 4 per cent in the not too distant future.

If that is the case, charities might well want to delay locking up any money, because better rates might be around the corner. With fewer people in the market ready to buy government debt, gilts are likely to fall in price, which could also have a knock-on effect on equities.

In addition, charities should expect inflation to increase to the MPC's 2 per cent target and then rise above it. Finally, sterling has been weak in the past two years and looks slightly undervalued, but it is higher than six months ago and the outlook for the UK economy relative to other countries has worsened; so it makes sense to introduce a bias in portfolios towards overseas assets.

 

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