LONDON, Nov 5 (Reuters) - The Bank of England extended its quantitative easing programme on Thursday, raising the size of its asset purchase scheme to 200 billion pounds from 175 billion. It also held interest rates at 0.5 percent.

The following is an exchange of letters between BoE Governor Mervyn King and Chancellor of the Exchequer Alistair Darling on the QE expansion.

LETTER FROM DARLING TO KING

Thank you for your letter of 5 November, setting out the MPC's case for raising the limit on purchases that may be undertaken by the Asset Purchase Facility.

In March 2009, I authorised the MPC to purchase up to £150 billion of assets financed by the issuance of central bank reserves, and in August I extended the limit to £175 billion, at the MPC's request. This facility has enabled the MPG to influence monetary conditions in the United Kingdom by influencing the quantity of money in the economy as well as by setting the level of Bank Rate.

Your letter of 5 November explains that the MPC judge that further purchases should be undertaken to enable the MPC to meet its objective of maintaining price stability.

I agree that an increase in the ceiling would provide the MPC with scope to vary the stance of monetary policy to meet the inflation target.

I am therefore writing to authorise an increase in the ceiling from £175 billion to up to £200 billion. As before, this sets a maximum overall limit within which the MPC will determine the scale of its purchases each month. In my letter of 29 January, I wrote that the objective of the Asset Purchase Facility is to increase the availability of corporate credit, in order to support the Bank of England's responsibilities for financial stability and monetary stability in the United Kingdom. There has been a welcome improvement in the markets for Commercial Paper and for investment grade Corporate Bonds since the start of the year, partly reflecting the support provided by the Facility.

I would welcome an update on the prospective use of the secured commercial paper facility. I am copying this letter to the Rt. Hon. John McFall MP, and depositing a copy in the library of both houses.

LETTER FROM KING TO DARLING

At its meeting today, the Monetary Policy Committee judged that, in order to keep inflation on track to meet the 2% inflation target over the medium term, its programme of asset purchases should be increased to a total of £200 billion and Bank Rate should be maintained at 0.5%. That would take the scale of the Committee's asset purchase programme above the £175bn authorised in your letter of 6 August.

The context for that decision can be summarised as follows. The world economy has shown signs of recovery, with a number of emerging market economies experiencing a strong rebound in growth, although global activity as a whole remains significantly depressed. Asset prices have risen internationally since the spring, reflecting both the gradual improvement in the economic climate and accommodative monetary policies. And banks' funding conditions have improved, though financial conditions remain fragile.

In the United Kingdom, output has fallen by almost 6% since the start of 2008. Households have reduced their spending substantially and business investment has fallen especially sharply. GDP continued to fall in the third quarter. A number of indicators of spending and confidence, however, suggest that a pickup in economic activity may soon be evident.

CPI inflation fell to 1.1% in September, having been 5.2% a year earlier. Inflation is likely to rise sharply to above the 2% target in the near term, reflecting higher petrol price inflation and the reversal of last year's reduction in VAT.

The medium-term prospects for output and inflation continue to be determined by the balance between two opposing sets of forces. On the one hand, there is a considerable stimulus still working through from the substantial easing in monetary and fiscal policy. The Bank's asset purchases have helped to boost asset prices and improve access to capital markets.

The sterling effective exchange rate lies around a quarter below its mid-2007 level, improving the competitiveness of UK producers. On the other hand, the need for banks to continue the process of balance sheet repair is likely to limit the availability of credit. And high levels of debt will weigh on spending.

On balance, the Committee believes that the prospect is for a slow recovery in the level of economic activity, so that a substantial margin of under-utilised resources persists. That will continue to bear down on inflation for some time to come, offset in the short run by the impact of the past depreciation of sterling.

I am therefore requesting the authority to use the Asset Purchase Facility to purchase assets totalling £200 billion. The structure and operation of the Asset Purchase Facility would otherwise be unchanged from that described in your letter of 3 March.

I am copying this letter to The Rt Hon John McFall MP, Chairman of the Treasury Committee. Keywords: BRITAIN BANK/QE LETTERS

(UK Economics Desk; +44 20 7542 2774)

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