Three Factions at the Bank of England

May 27, 2008

British monetary policy is decided by a committee of nine people, who as in many other G7 economies are challenged by weakening growth prospects as well as intensifying inflation. Of the last eight monthly policy meetings, only one resulted in a unanimous decision. Mr. Blanchflower was more dovish than the majority at the other seven meetings, and Deputy Govenor Gieve shared Blanchflower’s bias in both November and March. On the other hand, Messrs. Sentance and Besley were more hawkish than the majority five times since October 2006, including the meeting in April 2008. The Bank rate was cut by 25 basis points each in December, February, and April and presently stands at 5.0%. The vote earlier this month was 8-1 in favor of keeping 5.0%.

The majority is constrained from addressing a significant slowdown of British activity and rising risk of recession. Hometrack house price inflation of -1.9% in the year to May was at a 30-month low. According to British Banking Association data, mortgage approvals in March and April were at their lowest and second lowest levels since this data series began in September 1997. Consumer confidence is at a 16-year low. On-year M4 growth is at a 32-month low. The CBI industrial trends survey had an orders component of -13 in April and -10 in May compared to a monthly average reading in 1Q08 of +4. Real GDP growth slowed to just 0.4% in 1Q from 4Q, as business spending fell 1.6%. And retail sales volume slid by 0.2% m/m apiece in March and April.

U.K. inflation is climbing. The expected inflation component of the industrial trends survey was at its highest level since February 1995. The Bank of England staff expects several months of CPI inflation in excess of 3.0% compared to a target of 2.0%. A 4%-handle on CPI inflation later this year cannot be ruled out, and minutes from the May policy meeting clearly reflect worry that cutting rates in this environment might fan the rising trend in expected inflation. Monetary policy is now hostage to commodity price developments in the U.K. and many other places, too. Symptomatic of this shift in concerns from growth to prices, the cover story in this week’s Economist is about a return of inflation, but the article entitled “Inflation’s Back” refers to emerging markets, not major developed economies.



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