A Bank of England Surprise

May 7, 2009

The Monetary Policy Committee, which had not been expected to announce any policy changes, instead extended its asset purchase plan by Gbp 50 billion and for two more months.  In March, officials had said they would buy Gbp 75 billion of mostly government but also some corporate debt over a period of three months through May and fund that buying with central bank reserves (i.e. printing money).  They are averaging Gbp 25 billion per month, so the additional Gbp 50 combined in June and July should bring the total purchases for the five months through end July to Gbp 125 billion.  The plan will be reviewed at its June and July meetings.

As expected, the Bank Rate was kept at 0.50%, a rate that officials previously indicated would represent a floor.

In being more aggressive than expected, officials observed portents of moderation in the economy’s rate of decline, but their immediate statement also identifies a mixture of growth stimulants and drags going forward that make “the timing and strength of recovery highly uncertain.”  Although on-year CPI inflation of 2.9% remains above target, a drop below 2.0% is expected later in 2009 as unutilized capacity mounts, the labor market weakens, and food and energy base effects drop out.  Today’s expansion of quantitative easing was justified to raise inflation back to its 2% medium-term target.

Textbook theory suggests that sterling ought to soften as the central bank stimulates money supply growth, but that would happen only if money growth outpaces the jump in liquidity demand.  Sterling in fact has strengthened since the Bank of England began this program, and there is no reason to think that its response will shift significantly because of today’s step.  The uptrend in gilt yields, on the other hand, will likely get reinforced.

Further clarification of Bank of England policy will be provided in the quarterly inflation report due May 13 and minutes from this week’s meeting of the Monetary Policy Committee due May 20th.

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

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