Let the QE Roll

06-Oct (USAGOLD) — The Bank of England held the repo rate steady at 0.5% and announced an additional £75 bln in quantitative easing this morning. This was bigger and sooner than the market was expecting. Caught off-guard, Gilts surged and Sterling tumbled to a new 15-month low. The BoE cited strains in the bank funding market as the catalyst for their decision, but the central bank is also apparently worried that inflation will drop below the 2.0% target in 2012. The sovereign debt turmoil across the channel on the continent of Europe undoubtedly factored into the BoE decision as well.

While the economic outlook in the UK may indeed be grim, that second part of the BoE’s justification is dubious at best. Inflation is presently running at more than twice their target and is likely to hit 5% before the end of this year. If UK policymakers really believe the January VAT hike (in conjunction with lower energy and commodity prices) will tank consumption enough to net a 300 bps (or more) decline in inflation, they’d be better off reconsidering the tax hike than increasing asset purchases.

There is a considerable and growing record from a number of major economies that pretty decisively shows that QE has very little stimulative impact. Nonetheless, the absence of meaningful fiscal action on the part of lawmakers in industrial nations — because it will be painful to some of their constituency — means central banks must at least make some effort to stimulate via monetary policy…even if it is largely pointless.

The ECB also held steady on rates today and edged further down the QE path. In his last press conference as President, Jean-Claude Trichet also painted a bleak picture of Europe’s economy, saying, “The economic outlook remains subject to particularly high uncertainty and intensified downside risks.” He also anticipates that inflation will remain elevated in the months ahead, but will decline thereafter.

Trichet went on to announce that the Governing Council has decided to launch a new covered bond purchase program of €40 bln to be conducted in both the primary and secondary market, via direct purchases from November 2011 through October 2012. In addition to its regular and special-term refinancing operations, the ECB will also conduct two longer-term refinancing operations in October (12-month) and December (13-month).

Finally today, the Fed was a seller of $8.870 bln in shorter-term securities. The proceeds of this transaction will ultimately be used to fund the purchase of longer-dated securities as part of the Fed’s Operation Twist. While yields at the long-end of the curve have indeed come down as a result of Operation Twist, initial mortgage refinancing and new mortgage demand data suggest market reaction to the Fed’s program has been tepid, at least initially.

In testimony earlier in the week, Fed chairman Bernanke gave his own dire assessment of the US economy, saying the recovery is “close to faltering.” He hinted that the Fed had more bullets; suggesting that further monetary easing could be forthcoming. With interest rates already at zero and Operation Twist already being implemented, that further easing almost assuredly would be in the form of more full-on QE; debt monetization.

While gold’s reaction thus far has been nonplussed, the reality that the central banks seem to be spooling up their printing presses once again is likely to be seen as broadly supportive to the yellow metal. If/when it is proven that the latest measures aren’t having the desired affect, and once again in the absence of meaningful fiscal policy, do the central banks throw up their hands and say we’ve done all that we can do? Or, do they pile on additional measures? Because with an unlimited supply of ink and paper — or more appropriately computer bits and bytes — there is always more they can do…consequences be damned.