Quantitative easing, or QE, is a monetary policy where a central bank buys financial assets at scale, typically government bonds and sometimes mortgage or corporate bonds. The goal is to push longer-term interest rates down, support credit markets and make financial conditions looser when cutting policy rates is not enough.
The central bank pays for these purchases by creating bank reserves electronically. That expands its balance sheet, increases the banking system’s reserves and encourages investors to move into riskier assets with higher expected returns.
What exactly does a central bank buy and how are the purchases paid for?
Most QE programmes focus on government bonds across different maturities. Some include mortgage-backed securities or investment-grade corporate bonds to help specific credit markets. Purchases are almost always in the secondary market, meaning the central bank buys existing securities from banks, dealers or asset managers rather than lending directly to governments or companies.
Payment happens with newly created reserves. When the central bank buys £100 million of bonds from a dealer’s bank, it credits that bank’s reserve account by £100 million and takes the bonds onto its own balance sheet. The central bank’s assets go up by the bonds it now holds, and its liabilities go up by the reserves it created. No taxpayer cash changes hands at the point of purchase.
This action increases base money, which is currency in circulation plus bank reserves. It does not automatically increase broader money used by households and businesses unless banks extend more credit or sellers of bonds reallocate into deposits and spending. That is why the transmission channels matter.
Why central banks turn to QE instead of cutting rates
Conventional monetary policy uses a short-term policy rate to influence borrowing costs and demand. When that rate approaches zero, or when financial markets are strained, central banks may still want to lower longer-term borrowing costs and improve market functioning. QE targets those longer maturities directly by taking duration out of the market and signalling easier policy for longer.
Think of a shock that drags growth down and inflation below target. The policy rate is already very low, yet mortgage rates, corporate bond yields and term premiums remain sticky. By buying longer-dated bonds, the central bank compresses yields further out the curve and supports lending and investment, even with the overnight rate near zero.
How QE feeds through to yields, credit and equities
QE works through several channels that tend to reinforce each other:
- Portfolio rebalancing. Investors who sell bonds to the central bank receive cash-like reserves or deposits. They often redeploy into other assets with more yield, such as corporate bonds, equities or property, which pushes those prices up and their yields or required returns down.
- Term premium compression. By removing a chunk of long-duration bonds from the market, QE reduces the extra yield investors demand for holding longer maturities, lowering government and mortgage rates.
- Liquidity and market functioning. Large, steady purchases can stabilise stressed markets, narrow bid–offer spreads and reassure investors that trading will remain orderly.
- Signalling. A big balance sheet often signals that policy will stay easy for an extended period, shaping expectations about future short-term rates.
For equities, lower discount rates and improving credit conditions can lift valuations, especially for interest-rate sensitive sectors. A simple illustration: if a pension fund sells £50 million of long-dated government bonds into QE and reinvests £20 million into high-grade credit and £10 million into equities, that extra demand can compress credit spreads and support share prices.
QE, inflation and the currency
The policy aim is usually to raise inflation towards target by stimulating demand and nudging up inflation expectations. Lower borrowing costs help households refinance and firms invest, while higher asset prices can improve confidence and spending. The size of the effect varies with the state of the economy and the health of banks.
QE can influence the exchange rate. Lower yields relative to other countries may reduce demand for the currency, which can make exports more competitive and import prices higher. That said, currencies move for many reasons, including risk appetite and incoming data on growth and prices. Traders watch labour and inflation prints and timely growth surveys such as PMI when judging how QE might interact with the outlook.
What happens when QE is unwound, also called quantitative tightening
Central banks can unwind QE by stopping reinvestment of maturing assets, allowing the balance sheet to shrink gradually, or by selling securities back into the market. Either approach reduces reserves over time and tends to put upward pressure on longer-term yields, tightening financial conditions.
Unwinding can be sensitive. If sales are too quick or the market is thin, yields could jump and liquidity could suffer. Many authorities prefer a predictable, slow runoff that the market can absorb. Money markets also need enough reserves to function smoothly, so central banks often keep a buffer even after QT.
Limits, side effects and common misconceptions
Not the same as fiscal spending. QE changes the mix of assets held by the public and influences interest rates, but it is not a government spending programme. Purchases usually happen in the secondary market and can be reversed.
Asset prices and inequality. By design, QE lifts asset prices. That helps balance sheets and lowers borrowing costs, but it can widen wealth gaps because financial assets are unevenly held. Distributional effects are a frequent criticism.
Diminishing returns. The first rounds of QE often have the biggest impact, especially in a crisis. Later rounds may move markets less, particularly if investors are already flush with liquidity.
Bank profitability. A flatter yield curve can squeeze banks’ net interest margins. On the other hand, stronger loan demand and lower credit losses can offset that. Effects differ across banking systems.
Inflation risk. If QE is kept in place for too long, or applied into an economy already running hot, it can add to inflation pressures. Central banks weigh this against their mandates for price stability and employment, which vary by country and can change over time.
Reserves versus money in your pocket. People often call QE money printing. In practice, it creates reserves inside the banking system, not new banknotes, and broad money grows only if credit and deposits expand.
Credit easing and yield curve control. Some programmes focus more on buying private assets to improve specific markets, often called credit easing. Others aim at a target yield for certain maturities, known as yield curve control. These are related tools that can sit alongside QE.
What traders watch in a QE announcement
Market reaction depends on the details as much as the headline size. Common focus points include:
- Composition. Which maturities and what share of purchases go to government bonds, mortgages or corporate credit.
- Pace and schedule. The monthly run rate, any caps, and how purchases are distributed over time.
- Reinvestment policy. Whether maturing proceeds will be rolled over, for how long, and under what conditions.
- Conditionality and guidance. The economic thresholds for starting, extending or ending QE, and how it interacts with rate policy.
Traders also map out the supply and demand picture. If a government is set to issue heavily, a steady buyer in the central bank can offset the duration hitting the market and anchor yields. If the central bank hints at tapering purchases, term premiums can rebuild and curve shapes can change quickly.
In short, QE is a balance sheet tool aimed at lower long-term rates and easier financial conditions when conventional policy is near its limits. It appears in market conversations whenever yields, inflation paths and central bank balance sheets come into focus, and its effects ripple across bonds, credit, equities and currencies.