Quantitative easing is now well under way here in the UK. Despite the pages written in newspapers as various politicians and commentators explain its function, it is an untried policy – how does it work and will it work?

The clearest explanation I heard was from Dame Shirley Williams. She said that the UK banking system is constipated and QE is, in effect, a laxative, though one must be careful about the dosage!

With a purse of £150bn, the first target for the Bank of England (BoE) was the gilt market. Gilts are liquid and exist in significant quantity and buying them allows a swift and significant money expansion. Once the money has been created, it can be withdrawn by the selling of the acquired assets and thus drain money out of the system when the fight against inflation becomes an issue again.

Interestingly, the BoE is paying above par for the gilts so the taxpayer will suffer a capital loss. This action has driven down gilt yields and their prices up, bringing longer term interest rates down for the government. In driving down gilt yields, corporate bonds (which are priced off gilts) should also fall, thus reducing the cost of borrowing for corporates.

Last week the BoE announced its first move into the corporate bond market which, it is acknowledged, is a critical element of QE to ease the flow of corporate credit. The BoE defined what it regarded as “eligible” bonds being those “issued by non-bank financial companies, excluding building societies”. We have avoided the financial sector in the bond market and this, for now, seems to be the right tack. I am glad that Mervyn agrees with me. The BoE is to spend up to £50bn in this market and the list includes the 5.25 per cent Next 2013, 5.625 per cent Marks & Spencer 2014, and the 5.875 per cent National Grid 2024 bonds. There are a couple of others which attracted me: 5.25 per cent General Electric 2013 and the 6.875 per cent Prudential 2023, both of which are trading below par so investors will not suffer any capital loss if held to redemption. The list comprises only 114 bonds and many are over par so, for private clients, I find them less attractive.

The Bank was due to begin buying corporate bonds yesterday and I am hopeful we will see yields driven down and prices move sharply up – meanwhile we can enjoy the income.

WARNING: Opinions expressed are the writers’ judgments at the time of writing. The information does not constitute a personal recommendation and readers should seek their own professional advice as to the suitability of the investments.