IMF backing for Bank could signal more quantitative easing

• Britain's credit system needs 'continuing support'
• MPC member says policy is helping thoughout economy

The International Monetary Fund has warned that the UK's economic recovery will be muted. Photograph: Matthew Cavanaugh/EPA

The International Monetary Fund today gave the all-clear for the Bank of England to step up its electronic money-creation programme as a leading Threadneedle Street policy maker said the benefits of "quantitative easing" were being felt in factories and high streets across the UK.
On the day that the fund used its half-yearly health check of global financial conditions to warn that a dearth of credit risked derailing Britain's economic recovery, professor David Miles said the use of QE to offset weak bank lending was having "significant effects".
Miles said: "QE is having an impact and that is relevant to economic conditions right across the country". He said it was being felt not only in London financial markets but "in high streets and factories and homes throughout the country".
Miles, one of the nine members of the Bank's monetary policy committee, said it was hard to assess how many gilts the authorities would need to buy to boost spending in the economy.
The central bank is ramping up its purchases of assets to £175bn. Although Bank governor Mervyn King and Miles wanted last month to increase the programme to £200bn, they were outvoted by a majority of their colleagues on the MPC, who opted for the lower figure.
Most economists think quantitative easing has helped to stabilise the economy as well as to push down gilt yields and thereby borrowing costs across the economy, aiding a fledgling recovery. Commercial bank lending to households and businesses remains frozen, although QE was not designed to increase bank lending as such.
Miles's remarks came as the IMF's Global Financial Stability Report noted that the UK was particularly vulnerable to credit constraints caused by the weakness of bank lending and by the need to finance the government's rapidly rising deficit.
Over 2009 and 2010, the fund estimates the UK will have a funding gap totalling £430bn. At 15% of GDP that is much higher than the 2.4% projected for the United States and the 3% for the eurozone.
"The UK appears most susceptible to credit constraints … given its significant reliance on the banking channel and the projected sharp decline in domestic bank balance sheets, as well as substantial public financing needs."
José Viñals, the IMF's financial counsellor, said there was "significant tension" in the UK between the credit needed to sustain recovery and the current supply. "Either there is continuing support on the part of the authorities to underpin the credit process or there would be high lending interest rates or credit would be constrained," he said.
Although his comments do not amount to an explicit call for more QE, they do indicate the IMF would not stand in the way of an enhanced programme.
The stability report said the UK's reliance on foreign investors to finance the budget deficit made it vulnerable.
"The recent "Evidence of increasing home bias among investors poses a particular risk to interest rates in the US and UK as they seek to finance large deficits."
For the first time since the financial crisis began in August 2007, the Fund cut its estimate of the write-downs facing banks and other financial institutions. In the spring it predicted a $4tn bill (£2.5tn) but has now pared this back to $3.4tn.
It said the financial sector was only halfway through the write-down process, with American banks further advanced than those in Europe. US banks have recognised 60% of anticipated losses against 40% for banks in Britain and the eurozone.
Nevertheless, Viñals said, the world economy appeared to be on the mend.
"Over a year has now passed since the Lehman Brothers bankruptcy prompted a potential global financial meltdown. Fortunately, the situation is very different today due to unprecedented policy actions and the overall improvement in economic conditions. We are on the road to recovery, but this does not mean that risks have disappeared."
Despite the rally in stockmarkets and an easing in the price of credit in recent months, the IMF said it was too early to claim that the crisis was finally over.
"The risk of a re-intensification of the adverse feedback loop between the real and financial sectors remains significant as long as banks remain under strain and households and financial institutions need to reduce leverage."