The Bank of England will officially begin creating new money on Wednesday, offering to buy 2 billion pounds of government bonds, as it attempts to pull the economy out of recession and ward off deflation.
The auction is the first tranche in the central bank's so-called "quantitative easing" program, which opens a new front in its fight against the downturn after policy makers almost ran out of room to lower interest rates further.
The bank has committed to a 75 billion pound asset buying program, the first time that modern Britain has resorted to the measure, after a series of interest rate cuts in recent months that have brought them to a record low of 0.5 percent.
Colloquially known as "printing money," quantitative easing means the bank will in fact buy assets, such as government securities and corporate bonds, over three months and pay for them by crediting banks' reserve accounts — effectively creating new money.
It will start the process by buying government gilts through twice-weekly auctions on Mondays and Wednesdays.
The bank will purchase the securities via a reverse auction, which means sellers, rather than the buyer, determine the price, and it is relying on investors such as life assurance companies, pension funds and investment funds to part with their bonds.
The theory is that selling securities will cause bond yields to fall, making it cheaper for companies to borrow on the capital markets while institutions that have sold gilts to the bank will have extra funds to lend.
Economists said the bank should easily find sellers, as the price-setting mechanism is geared to boost the money supply, rather than make a profit.
But the success of the program will depend on the extent to which banks lend the newly created money.
"In theory, the 'multiplier' effects are potentially very powerful and could turn the initial 75 billion of asset purchases into a sharp rise in nominal GDP," said Jonathan Loynes of Capital Economics.
"But these effects are likely to be very muted in the current economic environment, as banks decide to hoard a proportion of the rise in their reserves and firms and households sit on cash rather than spend it," he added. "If so, the impact of the policy could be almost negligible."
With 75 billion pounds to spend over three months, the Bank will be buying around 5 billion pounds a week on average, but it could increase the size of auctions if the funds are oversubscribed with would-be sellers.
The British government has authorized a maximum of 150 billion pounds for the program and the Bank of England said that it will adjust "the scale of purchases as appropriate" after monitoring its effectiveness at its future meetings.