In response to the steady stream of bad economic news in recent weeks, on Thursday 6 Ocotober 2011 the Bank of England announced that they had authorised the injection of a further £75bn into the UK economy through quantitative easing.
Mervyn King, governor of the Bank of England, described the on-going economic crisis as one of the worst the country had ever seen and explained that this second round of quantitative easing was necessary because the amount of money in the economy was not growing quickly enough to sustain a recovery.
So what exactly is quantitative easing and how does it affect property investors and property prices ?
Quantitative easing (QE) is a practice carried out by central banks which, whilst often referred to as “printing money”, actually involves new money being issued in the form of a deposit at the central bank. The money is used to purchase government bonds and sometimes other assets.
The theory behind the practice is that adding more money into the system will depresses the value of the currency, push up the value of the assets being bought and lower longer-term interest rates, which, in turn, should encourage more borrowing and investment.
How does QE effect the property market ?
It is generally agreed that the exact impact of QE is very difficult to quantify accurately, but most commentators appear to agree that it is supportive of asset prices, including property.
There is, of course, a very recent historical precedent, in the form of the Bank’s first round of QE which was initiated in March 2009 and saw £200 billion of assets purchased.
Interestingly, the initiation of QE in 2009 coincided with the end of the slump in property prices and the subsequent partial recovery. Many commentators have argued that QE was an important factor in this recovery. Whilst it is likely to have had some positive effect on prices we should not forget that around the same time interest rates were slashed to the current record low of 0.5% and, unlike QE, interest rates tend do have a very direct and measurable effect on property price movements. I think it is fair to say that the reduction in interest rates probably had much more of an impact on recovering prices than QE.
So, how does QE support property prices ?
There are a few ways in which QE can indirectly support property prices. As QE involves the mass purchase of government bonds this has the effect of lowering the cost of government borrowing. As the cost of fixed rate mortgages is closely linked to the cost of government borrowing the result is likely to be a lowering of the costs of fixed rate mortgages taken out by new borrowers.
When government bonds are purchased from investors with newly created money, a lot of this money is then re-invested in bank debts or mortgage-backed securities. This creates a greater pool of wholesale funding that UK banks can access to meet their borrowing needs. Not only does this make it easier to refinance the large amount of government backed funding that is currently expiring , it also allows them to reinvest further funds in to mortgage lending.
We should also consider the fact that many economists believe that, in the long term, QE is likely to result in higher inflation as the new money slowly filters through the entire economy. If this has the effect of increasing inflation expectations amongst the investor community, a likely result is a move away from cash holdings towards property related assets.
So, in conclusion, if we accept that, to a greater or lesser extent, quantitative easing is likely to increase the amount of funding available for property purchases, lower the rates charged on fixed rate mortgages and push more investors towards property as an asset class then QE is likely to provide some support for property prices over the coming months and years.
However, I would argue that QE is probably not anywhere near as important a factor as low interest rates in supporting the property market. But the news on interest rates remains good for mortgage holders. Rates were held at 0.5% by the MPC on 6 October 2011 and, with a Bank of England statement saying "The deterioration in the outlook has made it more likely that inflation will undershoot the 2% target in the medium term “ they look set to remain low for a long time yet