Dire warning as bank starts printing money

The Governor, Sir Mervyn King, was speaking after the decision by the Bank's Monetary Policy Committee [MPC] to put #75 billion ($119 billion) of newly created money into the economy in a desperate effort to stave off a fresh credit crisis and a UK recession.

Economists said the bank's decision to resume its quantitative easing [QE], or asset purchase programme, showed it was increasingly fearful for the economy, and predicted more such moves ahead.

He said the bank had been driven by growing signs of a global economic disaster. "This is the most serious financial crisis we've seen, at least since the 1930s, if not ever. We're having to deal with very unusual circumstances."

Announcing its decision, the bank said that the eurozone debt crisis was creating "severe strains in bank funding markets and financial markets". The bank's MPC also said that the inflation-driven "squeeze on households' real incomes" and the government's programme of spending cuts will "continue to weigh on domestic spending" for some time to come. The "deterioration in the outlook" meant more QE was justified, the bank said.

Analysts said the MPC's actions would be a "Titanic" disaster for pensioners, savers and workers approaching retirement.

Under QE, the bank electronically creates new money which it uses to buy assets such as government bonds, or gilts, from banks. In theory, the banks then use the cash to increase lending .

By increasing the demand for gilts, QE pushes down the interest rate yields paid to holders of these and other bonds. Critics of the policy say it pushes up inflation and drives down the currency.

The National Association of Pension Funds called for urgent talks with ministers to address the negative impact of lower gilt yields . The chief executive of the association, Joanne Segars, said QE made it more expensive for employers to provide pensions and would weaken the funding of schemes.

"All this will put additional pressure on employers at a time when they are facing a bleak economic situation," she said.

Ros Altmann, an economist and pensions expert, said the latest round of QE would increase pensioner poverty. As well as fuelling inflation, falling bond yields would make annuities more expensive, "giving new retirees much less pension income for their money and leaving them permanently poorer in retirement".

The MPC also voted to keep interest rates at a historic low of 0.5 per cent, another decision that hurts savers. Protesters outside the bank's headquarters smashed a giant piggy bank to symbolise the situation of those forced to raid savings to keep up with the rising cost of living.

Asked about the plight of savers, Sir Mervyn said it was more important to support the wider economy than to support them.

Some analysts believe this round of QE could be less effective than the previous one, forcing the bank to create even more money this time.

Citigroup economist Michael Saunders said there could be as much as #225 billion ($358 billion) more QE by next year. "I think they will do lots more. It's both that the economy is weak, but also that the MPC's view is that QE is not a very powerful tool, or rather it takes a large amount of QE to have much effect on the economy."

The Bank of England is supposed to keep inflation near a target of 2 per cent. But inflation now stands at 4.5 per cent, and the bank admitted it is likely to hit 5 per cent soon. The bank's own research shows that as well as stimulating the economy, QE pushes up prices.

The Governor insisted the MPC's decisions had been the correct response to events. "The world economy has slowed, America has slowed, China has slowed, and of course particularly the European economy has slowed," he said. "The world has changed and so has the right policy response."

Traders in the UK took heart from the bank's move to boost growth, with the FTSE100 rising 3.7 per cent.

The bank's decision to increase QE came after political pressure from ministers worried Sir Mervyn was not reacting urgently enough to the global economic outlook.