Hard data on economic growth, manufacturing production and exports from the likes of the US, China, Japan, and Korea, point to a return to growth for the global economy in the third quarter.

In recent months the deliberations of the nine sages of the Bank of England’s Monetary Policy Committee have become somewhat tame, and even a little dull. With Bank Rate having been cut to just 0.5% in March, and likely to be left there until well into next year, the only point up for meaningful discussion has been whether to tinker with the Asset Purchase Facility through which quantitative easing (QE) is being conducted.

Having agreed in May to boost the QE programme to £125 billion, at last month’s meeting they opted to put off any further decisions until August when a new set of economic forecasts would be available.

As it happened this month’s announcement was far from dull, springing a surprise by extending the asset purchase programme by a further £50 billion to £175 billion. With mounting evidence that the global economy is emerging from recession, and that the UK is likewise on the cusp of recovery, most pundits had expected that the Bank of England would either call a halt to the QE programme, or extend it only by the £25 billion still available under the approval originally granted by the Government in March.

In simple terms, the object of QE is to improve liquidity in the financial system and boost the flow of finance available to households and businesses. It is still too soon to judge whether it has done any good, and given that it’s only been tried once before (in Japan earlier this decade), there’s no definitive proof that it will ever make a meaningful contribution to the process of economic recovery.

In that respect at least, this month’s MPC decision was a bold one. Above all, it suggests that the Committee was unconvinced that the recovery will be sufficiently robust that inflation returns to the 2% target in two years.

In particular, the Committee wasn’t swayed by the stream of upbeat economic news from around the world, which has propelled stockmarkets and commodity prices higher during the past few weeks. The latest crop of PMI (Purchasing Managers’ Index) surveys covering July indicated further improvement in the business climate in the world’s major economies. They pointed to expansion in China’s manufacturing industries and in Britain’s services sector, and a return to growth in British manufacturing – the first since last May. These results, together with hard data on economic growth, manufacturing production and exports from the likes of the US, China, Japan, and Korea, point to a return to growth for the global economy in the third quarter.

Here in the UK, there has also been a clear improvement in the hard data. Industrial output rose by 0.5% in June, with the production of manufactures up by 0.4%. With help from the car scrappage scheme, the number of new car registrations increased by 2.4% in the year to July, the first rise since April 2008.

The only bad piece of news of recent weeks was the larger than expected decline of 0.8% in the UK’s GDP in the second quarter. Despite the likelihood of this figure being revised, it was specifically mentioned in Mervyn King’s letter to the Chancellor, suggesting that it was a significant factor ithe decision to extend QE.

The other factor that clearly weighed on the minds of MPC members was the state of credit markets.A key concern for the months ahead is whether a nascent recovery will be choked by a shortage of bank lending. It is encouraging that several of the British banks are now profitable again, albeit that this was largely down to their investment banking operations. But Mervyn King’s letter warned: ‘though there are signs that credit conditions may have started to ease, lending to business has fallen and spreads on bank loans remain elevated’. The much-trumpeted increase in lending to small businesses in June does not detract from the fact that between March and June net lending to businesses by banks and building societies fell at an annualised rate of 5%, a steeper fall than in the final three months of last year.

The situation isn’t much better in the personal market. Although the number of loans approved for house purchase rose again in June to reach 47,000, its highest level in 15 months, net lending to individuals rose at an annualised rate of just 0.5% in the three months to June.

The weakness of lending might be explained as much by a lack of demand as by a lack of appetite and capacity on the part of banks. But it still seems odd that the flow of lending to businesses was weaker in the second quarter than it was in the first quarter. The acid test will come during the next few months when a return to economic growth is bound to increase the demand for finance.

The extension of QE should therefore be seen as a further signal of the MPC’s commitment to do whatever is necessary to restore the flow of credit. Past statements have made it clear that they believe the risks of doing too much are less than the risks of doing too little. But it is also significant that they only sought an extension of £25 billion over and above the existing mandate for £150 billion.

This suggests that they thought one final dose of QE medicine was worth administering as insurance against the recovery being starved of credit. The likelihood is that when they next discuss the QE programme in earnest, which will be at November’s meeting, they will decide to call a halt.

Mark Berrisford-Smith

Senior Economist, HSBC Bank plc

7 August 2009