Bank of England shocks markets, keeps bond purchase total steady

The Bank of England decided on Thursday to stick to its program of pumping 125 billion pounds into the economy, defying expectations it would expand its bond purchases and boosting fears it may be about to end the scheme.

Financial markets had expected the central bank to raise its program of quantitative easing by another 25 billion pounds, as the last of the 125 billion pounds looked set to be spent on government bonds and corporate debt within the next fortnight.

The BoE said it would make the remaining funds last another month, when it would review the QE program.

Some economists said the central bank may prefer to wait for its quarterly inflation forecasts in August but then could expand the purchases after all.

There'll be a short hiatus, said Brian Hilliard, UK economist at Societe Generale. But I think in August they will extend by at least 50 billion -- and maybe a total of 200 billion would be more sensible as they don't have to spend it all.

Nonetheless, gilt futures fell more than a full point and the pound rose around half a cent against the dollar as investors bet the BoE is now done with QE. Analysts had mixed views about whether the BoE meant to signal an end.

They haven't closed the door on further purchases ... but (the fact that) they have reached this decision today ahead of the Inflation Report sends a very clear signal that that is probably it. Big gilt purchases are almost certainly behind us, said Ross Walker, UK economist at Royal Bank of Scotland.

ECONOMIC FREE-FALL OVER

Britain's economy was in free fall in February when the BoE first proposed boosting the economy by buying financial assets with newly printed money in an effort to persuade banks to lend more freely to the rest of the economy.

The economic slide has now leveled off, although a swift return to growth looks less likely than a month ago.

Unemployment is still rising, manufacturing is still contracting and the recent pick-up in services activity may be little more firms re-stocking after running down their inventories. But even BoE policymakers have accepted that there is limited evidence that quantitative easing has directly helped the economy.

Figures published by the Bank of England Thursday showed the average interest on two- and five-year fixed rate mortgages jumped by around 50 basis points in June, and banks have reported that they are only slightly more willing to lend.

Other central banks which have partly followed in the BoE's footsteps of taking extraordinary measures to revive credit markets have also reported mixed results.

The European Central Bank has lent banks hundreds of billions of euros in 12-month funds, only to find they are hoarded in overnight deposit accounts, and has yet to settle any deals in its own 60 billion euro asset purchase program.

As a result, the BoE could move toward a more targeted approach to quantitative easing in future, economists said.

It may be that the Bank wants to target the problem more specifically and will be buying other types of assets in future, said Stephen Lewis, economist at Monument Securities.

If so, British companies are uncomfortable with the idea that different measures may help them more.

After only five months, it is still too early to determine the effects on the wider economy. So a further extension through the autumn is needed, and clear communication of the Bank's intentions throughout will be critical in order to prepare the markets, said Ian McCafferty, chief economic advisor to the CBI, Britain's biggest corporate lobby group.

(Additional reporting by Sumeet Desai, Christina Fincher and Fiona Shaikh; editing by David Stamp)