Alistair Darling's letter to Bank of England Governor/ Mervyn King's letter to Chancellor

The Bank of England today embarked on radical moves to “print money” in an aggressive new phase of its battle to combat Britain’s economic slump.

In a landmark decision that marks a determined stepping-up of its fight to end recession and secure a recovery, the Bank confirmed it is beginning a strategy of so-called “quantitative easing”. It is to pump £75 billion of newly created money into the economy over three months.

The ground-breaking step came as the Bank’s rate-setting Monetary Policy Committee also pushed interest rates to yet another historic low.

The MPC ordered another half-point cut in base rate from an existing 1 per cent that was already the lowest in the Bank’s 314-year history to a new all-time low of 0.5 per cent.

But the focus of interest on today's crucial decisions from the Bank was on the move to press ahead with the measures of so-called “quantitative easing”, or “QE”.

These have become necessary in part because with interest rates having been cut so sharply in recent months, the Bank is close to the zero limit below which rates cannot fall.

The green light for today’s drastic action was given by the Chancellor in a letter to Mervyn King, the Bank’s Governor, released today alongside the MPC’s announcement that it will immediately put to work its new powers to pump up the amount of cash and credit flowing in the economy in an attempt to jump-start growth.

The MPC’s decision to press on rapidly with QE, signalled a fortnight ago in minutes of its last meeting, means that it will now begin buying from commercial banks a range of corporate bonds (businesses’ IOUs) and Treasury gilt-edged stock or “gilts” (Government IOUs).

The Bank will pay for these assets by creating new money, electronically, in a modern-day version of running its printing presses.

The freshly-created cash paid to the banks for these assets will be credited to their Bank of England accounts. In turn, the banks should be able to make new loans to businesses and consumers backed by this increased funding.

The Bank’s intervention in the markets will also be carefully designed to drive down commercial interest rates paid by consumers and borrowers, as well as by the government on official borrowing, delivering a further boost aimed at breathing life into the economy.

However, the plan is also fraught with uncertainties and risks. Since the measures have been used only rarely in past decades, and the economy has since gone through sweeping changes, as well as recent upheavals, the Bank cannot be sure how much money it needs to create to make a difference.

City economists say that it will therefore have to experiment with the new weapon of QE and monitor developments carefully to see how its efforts are working.

Similarly, the Bank’s officials will have to work hard to determine which types of assets it should buy in order to make the policy most effective.

This morning’s decisions come as the plight of the economy continues to worsen.

Britain is already in the grip of the deepest recession for more than three decades after GDP plunged by 1.5 per cent in the final three months of last year, following a 0.7 per cent drop in the third quarter.

The Bank, which recently revised down its already dire forecasts, has signalled that it expects a similar slump in the first three months of this year.

Many economists expect that there will be little sign of recovery until the end of this year, or early next.

The Bank’s latest grim projections suggest that the economy could be shrinking at an annual rate of as much as 4 per cent at a low expected during the summer. Over 2009, the MPC’s “risk-adjusted forecast”, factoring in dangers of new blows to the economy, is for GDP to drop by 3.7 per cent.

Recent data gives scant sign of any imminent revival in economic conditions. A key survey this week showed activity at factories at near-record lows last month.

The normally more resilient services sector also continued to slump last month, although its pace of decline eased for the third month in a row. Companies in the vital services sector reported that they are being forced to slash prices and cut jobs at near record rates, giving little reason to hope for an imminent recovery.

A critical fear remains over consumer spending, which dropped by 0.7 per cent in the final quarter of last year — the biggest decline since the early 1990s, according to official figures.

The credit drought is also continuing to tighten its grip on both businesses and consumers. Figures earlier this week showed that mortgage lending remained close to record lows in January, with only 31,000 loans approved for new house purchases, down 55 per cent compared with January last year.

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