A beginners guide to QE and QT – and why it matters to you

Acronyms and abbreviations are very much part of our everyday language but when it comes to financial abbreviations, they can seem a little daunting, especially when it seems everyone else already knows the answer!

So let’s break down quantitative easing, or QE, and its buddy, quantitative tightening (QT).

You might’ve heard about central banks like the Bank of England or the Fed (that’s the one in the U.S.) doing some “money magic”. Essentially, QE is when these central banks whip up more money and start buying up various things, like government bonds (debt issued from the UK or US government, for example) or even corporate debt and mortgage debt.

What’s the deal with Quantitative Easing?

The idea behind QE is the same as lowering interest rates. It increases the money supply and injects more money into the economy.

QE is a bit like getting a little extra allowance money when you’re a child. Your parents may do this to encourage you to spend more, save more, or even invest in cool stuff.

Similarly, central banks hope that by pouring more money into the economy, it’ll get people excited to spend, invest, and drive the economy forward.

Now, when these banks go around buying your government bonds off you, investors are left with a pile of cash in hand. The catch? You’ve got to do something with it.

What happens is some investors will venture away from those government bonds and head towards riskier investments – this is because government bonds weren’t bringing in a high enough yield.

The QE conundrum: too much of a good thing?

Too much money swirling around without enough things to buy can lead to trouble.

Think of it like this: if everyone wants the same limited-edition trainers but there aren’t enough pairs to go around, the prices shoot up, right? That’s the problem with too much demand, it can lead to inflation.

And that’s the concern with QE — it can pump up demand so much that there aren’t enough goods and services to satisfy everyone, which can lead to prices climbing. Sound familiar? That’s what’s been going on lately.

Enter Quantitative Tightening

So, to combat this inflation bonanza, central banks do a little switcheroo called quantitative tightening, or QT. It’s basically the reverse of QE. 

Instead of tossing money into the mix, they start pulling some out. 

How? Well, when those bonds the central bank bought reach their due date (maturity) and the money comes back, the bank says, “Nope, we don’t need it anymore,” and just like that, the money vanishes into thin air (or near enough, you get the idea). It’s like your savings disappearing from your piggy bank, but on a grand scale.

And in the case of the Bank of England, they’re not just letting those bonds sit around — they’re actually selling them off and scrapping the money they get back. This shrinks the amount of money sloshing around and trims down the central bank’s financial statement.

So, there you have it! 

Think of it like this, QE is the party starter, gets the money flowing, while QT is the friend who says, “Okay, that’s enough dancing, time to head home.”

This article is provided for information only. The views of the author and any people quoted are their own and do not constitute financial advice. The content is not intended to be a personal recommendation to buy or sell any fund or trust, or to adopt a particular investment strategy. However, the knowledge that professional analysts have analysed a fund or trust in depth before assigning them a rating can be a valuable additional filter for anyone looking to make their own decisions. Past performance is not a reliable guide to future returns. Market and exchange-rate movements may cause the value of investments to go down as well as up. Yields will fluctuate and so income from investments is variable and not guaranteed. You may not get back the amount originally invested. Tax treatment depends of your individual circumstances and may be subject to change in the future. If you are unsure about the suitability of any investment you should seek professional advice. Whilst FundCalibre provides product information, guidance and fund research we cannot know which of these products or funds, if any, are suitable for your particular circumstances and must leave that judgement to you. Before you make any investment decision, make sure you’re comfortable and fully understand the risks. Further information can be found on Elite Rated funds by simply clicking on the name highlighted in the article.