How does Quantitive Easing work and will it make a difference to SMEs?

The UK’s Monetary Policy Committee (MPC) is determined to inject as much as £100bn into the economy, with a further £50-75bn in February 2012. Jamie Jemmeson of Global Reach Partners looks at how this is likely to help the country's SME sector.

How does QE work?

Quantitative Easing (QE) works by artificially creating new money to buy assets from private institutions. In the UK, this consists of both government bonds and high quality corporate debt instruments. In theory this has several initial benefits.

  • Firstly, the purchase of financial assets should push up price and provide liquidity and thus a flowing credit market
  • Secondly, additional money in the economy means that private sector institutions receive cash, which they can spend on goods and services
  • Finally, bank reserves increase.

The combination of these implications should have several knock on effects. It should lead to bank reserves increasing, leading in turn to an increase in lending to households and businesses. Higher asset and debt instrument prices result in lower yields and lower borrowing rates. Higher asset prices also mean an increase in total wealth. The improved economic conditions then spill onto the high street. Confidence returns as employment and incomes improve, resulting in additional spending and growth which reboots the economy.

What has happened so far?

Analysts are divided about how well the last injection of QE worked. There are those who claim that QE was successful, arguing that the British economy grew by a relatively credible 1.2 percent between April and June 2010. This amounts to £20-30 billion more economic output, or £1000 for each household in the country. They also argue that it has helped the financial markets by keeping down the interest rate on Government Bonds. However, the opposite side of the argument, to say that QE failed is more compelling. It’s true the UK showed signs of exiting recession, but it was the last major economy to do so and the rebound rate was not sustained. The economy shrank by 0.5 percent in the last three months of 2010 and weak growth has been recorded throughout 2011. The main failing of the scheme is that lending to businesses and individuals is still sluggish; it needs to pick up for QE to work effectively.

How does this affect SMEs?

Many think-tanks and quangos have been calling for more QE. The injection into the financial system could give SMEs plenty of scope to look for new opportunities. The increase in QE could result in banks weakening policy on business loans; which would make money more readily available to SMEs. It may be time to dust off those plans for prototypes and new business plans, as there is a chance that these could be realised with the right backing. With the upcoming pre-budget report there is some speculation that the Government will encourage more business development, particularly for smaller businesses.

What happens next?

The question now is what happens next; what effect will the latest bout of QE have on the economy? The economic data suggests that there is a real chance that the UK economy could enter the dreaded double-dip recession. The market is already pricing in the likelihood that the Bank of England will be embarking on a further £50 billion of QE in February next year.

Does this extra injection mean that the initial planned £75 billion will not have the required impact on the economy? Unfortunately due to the economic turmoil in the Eurozone, the banks will more than likely be sitting on the funds from this initial round of QE to strengthen their balance sheets and reserves. This is in an attempt to protect themselves against the seemingly inevitable economic shocks of the future. It is unlikely that QE is the magic pill to restore confidence; the problem is that the Bank of England is left with very few options.

This doesn’t mean there is no hope for the future of Britain’s small businesses. There is definitely an increase in loans and facilities being offered to SMEs; but what we are seeing happen on the ground is just not proportional to the amount of QE being injected.