Bank of England Preview

July 7, 2009

After cutting the British Bank Rate to 0.5% by March from 5.0% at the start of last October and a cyclical peak of 5.75% until December 2007, Bank of England officials adopted quantitative easing with an asset purchase plan to purchase Gbp 75 billion within three months that was expanded in May to Gbp 125 billion by July.  I expect the asset purchase program to be enlarged again, this time by Gbp 25 billion.  Some but not all analysts share this view.  Data and market events over the past month are telling two stories.  The British economy went through the wringer, with GDP plunging 6.4% at an annual rate over the three quarters through 1Q08.  The recession has lost considerable energy recently, and positive growth could be close at hand.  The service sector PMI was above 50 at 51.7 in May and 51.6 in June, while the production component of the factory PMI also surpassed 50 to a reading of 52.1 in June.  The rise of unemployment has slowed, exports are better positioned, and house prices seem to be stabilizing.  That’s the good news. 

The bad news is that the recovery that follows this severe recession has a very fragile foundation.  Money and lending growth data fail to confirm that quantitative easing has begun to  alleviate difficult financing conditions for households and firms.  Consumer confidence remains low and may become associated with a rising savings rate.  The CBI industrial trends survey index sank to a 10+ year low in June, and the latest CBI retail sector survey failed to improve further as anticipated.  Since the June meeting of the Monetary Policy Committee, the Ftse dropped 4.5%, oil prices declined 9.3%, and sterling lost 1.4% against the dollar.  The London Sunday Times reported that an increase of the asset purchase plan to Gbp 150 billion is possible this Thursday, and the British Chamber of Commerce went a step further, arguing that such a move, and authorization to buy more than Gbp 150 billion if necessary eventually, are in fact advisable.

Central bank officials have been known to reject policy easing when urged to do so, lest the independence of monetary policy appear compromised.  This is not the time to put pride and principle before practicality.  Markets are telegraphing new doubt about the coming recovery of advanced economies, including Britain’s.  A wait-and-see stance by Bank of England officials could damage confidence in the economic outlook at its nascent stage.  The policy mistakes made in the Great Depression and Japan’s decade of in-and-out recession involved providing too little macroeconomic support, not too much.  Those are the best precedents to guide policy in present circumstances.  Inflation will be contained with wages posting an on-year increase of just 0.8% including bonuses.  Soaring British budget deficits and debt are truly worrisome, but the Bank of England at this juncture can best address that issue by making sure that economic recovery takes hold.

The Bank of England’s announcement will be made at 11:00 GMT on Thursday.

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



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