The Item Club, an economic think tank within the firm Ernst & Young LLP which uses the same financial modelling as the UK Treasury, says that the economy will grow twice as much as previously forecast with gross domestic product (GDP) increasing by 1%, as compared to 0.5% forecast in July, 2009.

The Item Club statement goes on to say that The Bank of England will assess the progress of its £175 billion programme Quantitative Easing scheme to buy bonds with newly created money as the interest rate-setting panel produces economic forecasts in November.

Peter Spencer, chief economist at the Item Club, said:
“The outlook for the next 12 months is certainly looking more positive than the last year but it is going to be a bumpy ride. There could still be substantial pain.”

“The revival in capital markets has been helped by the cash infusions from QE, but apart from that the results have been disappointing. The QE cash and low interest payments are being seen as an opportunity to pay down debt rather than spend, hindering economic recovery.”

“Policy will begin to tighten in early-2010. But these measures only provide a fraction of the extra income needed to close the government deficit. Whoever forms the next government faces a once in a generation challenge.”

The Office for National Statistics will release GDP performance data on Friday 23 October, 2009, and a small increase is expected by most commentators.

Guest Article by Neil Camp

It’s quite appropriate that the Bank of England’s new way of trying to save the U.K. economy, quantitative easing, sounds like a brand of laxative.

The economy is literally bunged up and the Bank of England is hoping that an initial £75 billion will help matters, and if not, a further £75 billion will be made available.

So what is quantitative easing? It’s not quite a matter of simply printing new notes, as many critics are trying to suggest. That’s been recently tried in Zimbabwe and doesn’t work, causing rampant inflation. But the big problem for the U.K. is deflation, not inflation.

Quantitative easing is all about flushing vast amounts of money into the system.

Now, a few basics. The Bank of England controls the flow of money into the U.K. economy. It effectively sells money to the country’s financial institutions at a given rate: the interest rate. By repeatedly lowering the interest rate – at the time of writing it’s 0.5% – it has tried, and failed, to get the banks to pass cheap money onto its customers, both personal and business.

So, the main problem is the lack of credit. This is desperately needed by companies to fund their businesses and people to fund their daily lives, and the reduction of interest rates have not relaxed the credit supply log jam.

But quantitative easing is not about giving money away for free at the ATMs. The new money is effectively swapped for assets, both good and bad, which are handed to the Bank of England by the financial institutions in exchange for the bundles of cash.

Now, the great fear is that the banks will gladly hand over assets, a number of them toxic, in return for the cash which they will then use to rebuild their balance sheets. So, what you might find is that having received £75 billion, the banks are solvent again, but their customers are still starved of credit.

Furthermore, quantitative easing doesn’t have a great reputation, with the Japanese having used it to little effect in the 1990s. But, experts put that down to the Japanese using the tactic too late, a case of trying to shut the door long after the horse has bolted. It led to what the Japanese called a lost decade, as it struggled to cope with deflation.

So, the Bank of England has struck quickly, playing what pundits see to be the last card in the pack. If it works, it will stimulate the dying economy. It if doesn’t, it will have wasted billions of money which could have been used elsewhere. And it might cause sudden and rampant inflation from which it will take generations to recover.

But what might turn out to be the biggest criticism is why the Bank of England, and behind them the Government, doesn’t make the money available through a financial institution that will guarantee it goes to the right people.

The Government controls Northern Rock and, in effect, HBOS, so why cannot they be given the money and ordered to distribute it via loans and credit.

Cynics might say that Bank of England is stuffed full of bankers whose primary concern is to help other bankers, despite what the Governor might claim. Others might say that the Government cannot favour one institution over another and that legal claims from those left out of the bonanza might follow.

One thing is for sure though, if it doesn’t work, we may all have to await financial Armageddon.

Guest Article by Neil Camp