But that is not the end of the matter, as investors need to do something with the proceeds from their asset sales. They could just sit on the proceeds, but it is more likely that in due course they will buy other assets, including those that offer a higher return. So, in the course of time, the whole range of equity and bond prices are driven up, lowering the cost of finance to companies and increasing its availability. Our purchases of corporate assets are intended to have the additional effect of improving the functioning of those markets. By standing ready to buy commercial paper and corporate bonds, we hope to improve their liquidity, lowering the spread above safe assets of equivalent maturity, and with it the cost of finance to business. 2  BIS Review 62/2009  There are signs that these measures are having a beneficial impact too. Spreads on commercial paper eligible for purchase have fallen by around ½ percentage point and the size of the market has increased by around 10%. Similarly, average spreads on sterling investment grade corporate bonds for industrial companies have declined by some 60 basis points and gross issuance of bonds by UK companies has been strong. These developments may reflect a range of influences, but feedback from market participants suggests that our purchases have indeed played a helpful role. In addition to these channels, the banks, finding themselves flush with extra reserves, may choose to lend them on, providing a further kick by boosting the supply of credit.
The inflation rate as measured by the more familiar Retail Prices Index has fallen even more sharply, reflecting the reduction in mortgage interest payments associated with the reduction in Bank Rate and falling house prices. When the recovery does come, as it surely will, the margin of spare capacity in the economy will begin to shrink and inflationary pressures will start to build again. So at some stage, we will have to begin withdrawing the large monetary stimulus. Although this may be some way in the future, some market participants and commentators are already starting to worry about whether we will be willing and able to accomplish this sufficiently rapidly to prevent inflation taking off, particularly given the scale of the Government’s prospective financing needs. Three points are worth making. First, the timing of the withdrawal of the monetary stimulus will be governed by the need to meet the MPC’s inflation objective, not by the Government’s financing needs. Second, with Bank Rate at its effective floor, we presently have only the asset purchase programme as a tool to stimulate demand. But when it comes to tightening policy, we have two instruments at our disposal: asset sales; and raising Bank Rate. It is not necessary to unwind the asset purchases before raising Bank Rate. Third, if we felt the need to drain the extra reserves from the system rapidly, we could also do it by exchanging the reserves for short-term Bank of England bills, allowing us to stagger the sales of the gilts.