Central banks continue to expand support in face of deflation threat

The Bank of England and the European Central Bank both announced expansions to their monetary stimulus programmes today, warning that low inflation or deflation remained a threat.

The Bank of England kept its overnight rate at 0.5% for the second month running, after dropping it from 1% in March. At the same time, it announced another £50 billion in asset purchases, aimed at increasing the supply of credit and stimulating economic growth.

The bank's monetary policy committee pointed out inflation, though still above the bank's 2% target at 2.9% in March, was likely to go below it later this year and would continue to fall. The steep drop in sterling's value against other currencies had tended to support inflation, it added, but this was being counteracted by the drop in food and energy prices and the general slowing of economic activity.

In January, the bank unveiled its asset purchase facility to purchase £50 billion in commercial paper and corporate bonds. The scheme - financed by the issue of Treasury bills - was expanded in March in an effort to combat deflationary pressure. The bank promised to buy £75 billion of high-quality government and corporate debt, to be financed through central bank reserves. Today's decision takes the total size of the facility to £125 billion, still within the total authorised amount of £150 billion.

The bank has already bought £52 billion in assets under the scheme since the switch from debt funding to reserve funding was made in March. Prior to that, it bought £985 million in commercial paper, financed by bond issuance.

Meanwhile, the European Central Bank (ECB) cut its refinancing rate by 25 basis points to 1% in the latest of a series of cuts since October 8 last year, when the rate stood at 4.25%. The ECB also announced it would start longer-term refinancing operations with a one-year term, in addition to existing schemes which run for six months, and would start to buy up euro-denominated covered bonds.

ECB president Jean-Claude Trichet said the moves were intended "to promote the ongoing decline in money market term rates, to encourage banks to maintain and expand their lending to clients, to help improve market liquidity in important segments of the private debt security market, and to ease funding conditions for banks and enterprises".

He added that the European economy was expected to continue weak for the rest of the year, although inflation would stay "below, but close to" the 2% target.