UK central bank acts after losing trust in Europe

Bank of England Governor Mervyn King has lost faith in European Governments' ability to resolve the region's debt crisis.

The central bank yesterday announced its biggest stimulus since the depths of the recession, citing "vulnerabilities" related to the euro-area turmoil. King said the move, the first loosening of UK monetary policy since 2009, was a response to what may be the worst financial crisis ever.

"It's pretty much a vote of no confidence in European officials," said Richard Barwell, an economist at Royal Bank of Scotland Group, and a former Bank of England official. "Either the virus is already in the UK so they had to respond, or they don't believe the problem will be sorted out. I lean toward the second because of how much they've done."

King's refusal to wait for European governments signals determination to shield the UK from a crisis that threatens to tip Britain's biggest trading partner into recession. It also shows concern that failure to protect bank funding markets risks recreating conditions that led to the collapse of Lehman Brothers Holdings three years ago.

The UK central bank, which left its benchmark interest rate at a record-low 0.5 per cent, raised the ceiling for so-called quantitative easing to £275 billion ($550 billion) from £200 billion. That is the biggest expansion since the first round of stimulus in March 2009.

"The external environment has definitely darkened," said Steven Bell, chief economist at hedge fund GLC in London. "Why do we need to wait for them to get their act together? The Bank of England is correct. It's a bold move, but a good one."

Bank shares have plunged this year on concern that they will suffer if Greece defaults and as European officials clashed over how to resolve the turmoil. The Bloomberg Europe Banks Index has fallen 30 per cent in 2011, compared with a 17 per cent decline by the Stoxx Europe 600 Index.

"This is the most serious financial crisis we've seen at least since the 1930s, if not ever," King said on Sky News.

While European officials agreed on a second aid plan for Greece in July, they've indicated they may reopen the deal to impose larger losses on banks as part of the bailout. The European Commission is pushing for a co-ordinated capital injection for banks to shield them from the fallout of a potential Greek default.

"The deterioration in the euro zone and the re-emergence of risks to the financial system add up to a very different picture from the one we were looking at six months ago," former Bank of England policy-maker Kate Barker said.

Weakness in UK data alone was enough to warrant the additional stimulus, said Michael Saunders, chief European economist at Citigroup in London. Britain's economy grew less than initially estimated in the second quarter, with gross domestic product rising 0.1 per cent, lower than the 0.2 per cent previously published, data this week showed.

British policy makers are prioritising the recovery over the threat from inflation, which was 4.5 per cent in August, more than double the Bank of England's target. The central bank said that the deterioration in the outlook makes it "more likely" that inflation will undershoot its 2 per cent goal in the medium term.

As the bank begins four months of bond purchases, King said he was "confident" the new measures would work.

The European Central Bank may also be losing patience with Governments, announcing yesterday a resumption of covered-bond purchases and year-long loans for banks. The ECB will spend €40 billion ($69.4 billion) on covered bonds starting next month and will offer banks two additional unlimited loans of 12- and 13-month durations.

- Bloomberg