What is quantitative easing and how does it affect the markets?

What is quantitative easing?

Quantitative easing (sometimes abbreviated to ‘QE’) involves the purchase of government securities by central banks in an attempt to stimulate economic growth.

Central banks are mandated to keep inflation within certain parameters to maintain a healthy economy. Normally, they do this by controlling interest rates, which is the amount of interest that banks pay to borrow money from one another. Interest rate changes are passed on to banks’ customers, so a reduction in central bank interest rates usually means consumers can borrow more cheaply, which increases spending and GDP. Lower interest can also mean that people earn less on their savings, incentivising them to spend their money instead.

However, if interest rates are already very low, central banks must look to other means to increase the monetary base. Quantitative easing entails the creation of new bank reserves that are used to purchase government bonds​ (for example, from pension funds). This increases bond prices, which reduces bond yields and lowers interest rates in the real economy.

Quantitative easing is often described as ‘printing money’. Money printing has, in the past, led to severe economic problems such as hyperinflation.

Central banks have recently used quantitative easing to mitigate the impact of the Covid-19 pandemic. For example, the Bank of England (BOE) – the UK’s central bank – bought £895bn of UK government bonds during 2020, in an attempt to maintain spending and investment levels while lockdown measures curtailed most economic activity.

Keynesian economic theory suggests these kinds of active economic measures can mitigate or prevent recessions by increasing aggregate demand.

How does quantitative easing affect the markets?

Different asset classes, including fixed income, equities and cash equivalents, are affected differently by quantitative easing. We explore a few of the financial markets below.