Bank of England Inflation Report Still Very Dovish

February 11, 2009

The Bank of England quarterly Inflation Report from last November signaled a further sharp drop in its interest rates by projecting CPI inflation of 0.8% in the medium term (4Q10) even if the repo rate stayed at the then lower level of 3.0%.  The repo rate is now just 1.0% after cuts of 100 bps in December and 50 bps last month and earlier this month.  One might suppose those further rate reductions would have lifted projected medium-term inflation in the new forecasts released today, but that’s not the case.  There is an upward hiccup late this year in response to some special factors, but the CPI settles back in 2010 and is only at 1.0% — a full percentage point below target, as 2011 gives way to 2012.  In the latest quarterly report, moreover, risks associated with the central CPI projection path are “judged to be slightly to the downside.”  The cause of this deflationary threat is a huge margin of spare capacity. 

Growth in the first quarter of 2009 will be similar to the 5.9% annualized GDP plunge last quarter. The projected business cycle retains a “V” shape, which I find implausible.  The nadir occurs around mid-2009, and the “V” has much greater amplitude, both down and up, than the forecast in November’s Report, rebounding from minus 4% to plus 3% by 2011.  Bank of England officials are counting on stimulus from fiscal policy, monetary policy, sterling depreciation, lower commodity prices, and actions by all governments to buoy bank liquidity and solvency.  At the same time, the authorities recognize the possibility of a less advantageous scenario and conclude that the risks around the central projection for growth “to be weighted heavily to the downside.”  Accordingly, the Report warns that “a further easing in monetary is likely to be needed.”  In subsequent remarks, Governor King clarified that since the scope for cutting nominal interest rates is diminishing, the implementation of easier credit policy would be shifting to unconventional and unconventional unconventional steps involving the purchases of a wide range of assets with intent to reinvigorate money growth, which is now too slow.

Copyright 2009 Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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