QE and QT explained

Joss Murphy 03/08/2023 in Basics, Fixed income

We’ve heard lots about quantitative easing and quantitative tightening in recent years as global governments have grappled with various monetary issues. But what do these terms actually mean?

Here, we take a look at what you need to know about both these policies and how they can affect your finances.

Quantitative easing (QE)

Quantitative easing is a form of monetary policy – often referred to as just QE – that shot to prominence after the global financial crisis of 2007-2008.

It’s best described as a tool to increase the supply of money and stimulate economies when the standard ways of doing so are no longer working. A prime example is when interest rates are already so low that reducing them further wouldn’t be enough to kickstart the economy and get people spending again.

What does QE involve?

QE involves buying government bonds, as well as corporate bonds, to push up their prices and bring down long-term interest rates. This process increases how much people can spend, which subsequently puts upward pressure on the prices of goods and services.

The hope, therefore, is that increasing money supply will give a much-needed boost to everyone’s finances – and often the stock market, too.

When has it been used?

A number of central banks have used quantitative easing in recent years, particularly during the global financial crisis and the Covid-19 pandemic.

In the UK, QE first appeared during March 2009 as the world struggled in a financial malaise, according to a report from the Bank of England (BOE). The BOE pointed out that the Bank Rate – which is sometimes called Bank of England base rate or just interest rate – was already very low.

“In fact, it couldn’t be lowered any further at that point,” it stated*. “So, we needed another way to lower interest rates, encourage spending in the economy, and meet our inflation target.”

According to the BOE, £895bn worth of bonds were bought*. “Most of those (£875bn) were UK government bonds,” it stated. “The remaining £20bn were UK corporate bonds.”

Has QE worked?

Well, yes and no. It all depends on your views. Those in favour insist it’s bolstered economies, but critics argue this has come at a price.

Quantitative easing is particularly effective as a tool to stabilise financial markets, concluded a report of the Economic Affairs Committee of the House of Lords**. “There is strong evidence that shows it is an effective monetary policy tool when it is deployed at times of crisis, when financial markets are dysfunctional or in distress,” it stated.

However, it hasn’t won universal acclaim. For example, the policy has been accused of increasing house prices to such an extent that first time buyers are finding it a challenge to get on the property ladder. There have also been suggestions that the extent of QE deployed played a significant part in the double digit inflation levels witnessed in the early 2020s.

Quantitative tightening (QT)

Now, let’s have a look at quantitative tightening. This is a contractionary policy – the opposite of QE – that happens when central banks tighten money supply.

According to an analysis by UBS, QT occurs when central banks start to reduce their balance sheets of the assets they bought during previous rounds of QE***. This can be triggered by a need to slow the economy down, particularly if inflation has taken hold and is soaring to sky high levels…and making life increasingly expensive for everyone.

What does QT involve?

According to investment manager Brooks Macdonald, QT is about taking back that money supply by selling assets rather than buying them. “In this way the central bank sells its balance sheet assets, basically all the bonds that they’ve got on their balance sheet at the moment and reduces the money supply floating around in the economy,” it explained.

When has it been used?

At the time of writing, QT is currently underway! The European Central Bank (ECB), for example, launched its quantitative tightening policy to unwind its portfolio of QE accumulated assets in March 2023.

The introduction of QE helped combat deflationary effects seen during the pandemic in 2020 but QT has followed in its financial wake, according to reports collated by the European Parliament^.

It noted how the combination of supply-side bottlenecks caused by Covid-19 in some regions, the quick reopening of the euro area economy in 2021 and a strong increase in energy prices because of the war in Ukraine in 2022, led to a sharp increase in inflation.

In fact, inflation was in double digits for the first time in four decades. “The ECB decided it was time to tighten its monetary policy after a decade of accommodative policies,” it stated^.

Of course, different central banks will attack QE and QT at different paces, noted Brooks Macdonald, which can affect the outcome. “It’s all very much related to what’s going on in that local economy which forms the basis of the decision as to whether easing or tightening is appropriate,” it added.

Will QT work?

The jury is out on whether or not the introduction of quantitative tightening will be a positive move. Investors are concerned that QT could significantly impact markets, noted UBS. “Over the past ten years, asset returns have displayed a high correlation with central bank purchases,” it stated***.

In fact, MPs on the Treasury Committee of the House of Commons launched an inquiry earlier this year (Feb 2023) to investigate its impact^^. In a statement, Harriett Baldwin MP, the committee’s chair, noted how the BOE had begun reversing more than a decade of quantitative easing, while also raising interest rates.

“We are in uncharted territory, which is why we are interested in evidence from a wide range of private and public organisations, academics and market participants, as we seek to understand whether the Bank of England’s plan is appropriate,” she said.

Listen to Richard Woolnough, veteran manager of M&G Corporate Bond, M&G Optimal Income and M&G Strategic Bond, all Elite Rated funds, discuss QT in this episode of the ‘Investing on the go’ podcast series.


*Source: Bank of England, 1 January 2023

**Source: House of Lords, Economic Affairs Committee, 1st Report of Session 2021-2022

***Source: UBS

****Source: Brooks Macdonald

^Source: European Parliament, Monetary Dialogue Papers, March 2023 

^^Source: UK Parliament, 2 February 2023

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