FTSE hits two-year high as US embarks on QE2

As you'd expect, the stock market seems rather happy about a massive $600bn cash injection into the world's biggest economy.

by James Taylor
Last Updated: 19 Aug 2013
It's been a good morning for the FTSE 100; the UK index jumped to its highest level in more than two years after the US Federal Reserve finally pushed the button on its second round of quantitative easing (QE2 to its friends). In fact, all the major world markets enjoyed a bounce this morning, presumably on the grounds that a cash injection of this mind-boggling size - $600bn, the equivalent of $75bn a month (and more than the forecast $500bn) - should give the US economy a boost, which in turn should be good for everyone else. Since the chances of QE3 are slim to minimal after the US mid-terms, let's hope they're right...

As the Fed admitted in a statement, its previous bout of QE - worth a whopping $1.75trn - has failed to revive the ailing US economy: 'the pace of recovery in output and employment remains slow... Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth and tight credit'. So it's throwing more money at the problem. And it's not just the $600bn - it's also reinvesting the proceeds from its previous investments in US mortgage debt, which amounts to another £300bn or so. You certainly couldn't accuse the US central bank of lacking the courage of its convictions.

The question is: will it work? Opinion is divided about the efficacy of QE1; although it clearly didn't solve the problem, some argue it stopped things being an awful lot worse. But the US continues to have the same problems we've had with QE here in the UK: despite all this extra cash sloshing around the company, it hasn't become massively easier for businesses and consumers to borrow from the banks (because of the latter's well-attested troubles). Equally, there are worries (even within the Fed) that this massive monetary boost will drive up inflation in the medium to long term.

On the other hand, did the Fed really have a choice? With US GDP growth still bumping along around the 2% mark, unemployment is creeping ever higher - it's already getting on for 10% of the working population. So something had to be done - and with interest rates already as low as they can go, the Fed didn't have many options.

It's a similar story here in the UK, where the Bank of England has just voted to keep UK interest rates on hold at 0.5% for the 19th month in a row. Unlike the US, the Bank has decided to keep our own QE programme at £200bn for the time being - but lots of people except Mervyn King and co to follow suit eventually, probably in the new year. Hopefully by then the news coming out of the US will look a little more positive...

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