Gilt yields fell sharply following the announcement of the asset purchase programme and our initial purchases of gilts. Yields have subsequently drifted back up, but this reflects a range of other factors and it is likely that yields are lower than they would otherwise have  4  BIS Review 86/2009  been. Borrowing costs within the commercial paper market appear to have fallen as a result of our operations. And in the corporate bond market, spreads have narrowed sharply in recent months and issuance levels have been at record highs. However, this has coincided with a global rally in corporate bond markets and so it is difficult to isolate the incremental impact of our purchases. Despite these encouraging signs, there have been some questions raised about the design and effectiveness of our operations, and I thought I would take this opportunity to address three particular criticisms that have been levelled against the asset purchase programme. The first is that the asset purchases have been too heavily skewed towards gilts and that we should have purchased a greater proportion of private sector debt. The aim of our purchases of corporate debt is to improve the functioning of corporate credit markets. This is in line with the remit specified by the Chancellor when establishing the Asset Purchase Facility. It is important not to judge the economic significance of these purchases by their scale. Even relatively small purchases of debt, if appropriately targeted, can improve liquidity and lower the cost of finance to businesses.
Despite those unprecedented falls in activity, there are some signs that the British economy is beginning to stabilise, and financial markets have improved markedly. There are three solid reasons for thinking that a recovery in activity was likely to occur at some point this year. The first I call the “Honda effect” – many firms, as Honda did last year at its plant in Swindon, cut back production and met demand from stock, resuming production this year once inventories had been reduced. The second factor is the level of sterling which, despite its recent rally, is still some 20% lower than in the summer of 2007. That will encourage a switch in spending, at home and abroad, towards goods and services produced in the UK. Finally, and perhaps most important, is the enormous policy stimulus that has been injected into the economy. Bank Rate was cut by four percentage points in four months. But the Monetary Policy Committee judged that even that was insufficient to prevent inflation falling below our 2% target, and so it embarked on a programme of asset purchases designed to increase the money supply and improve conditions in non-bank corporate credit markets. The programme will shortly be extended to working capital finance, which should be of particular help to smaller companies. But the Bank must not become the arbiter of the allocation of public credit to individual companies or sectors – such decisions are rightly and necessarily the province of government.