Why the Bank of England Did Not Respond to Green Shoots

August 20, 2009

The decision by British monetary authorities earlier this month to boost quantitative easing by 40% or Gbp 50 billion to total asset purchases of Gbp 175 billion was the biggest central bank surprise so far this month.  Minutes from that meeting published this week revealed an even greater surprise than realized initially.  Three of the nine Monetary Policy Committee members dissented in favor of a greater asset buying increase of Gbp 75 billion to Gbp 200 billion in total.  The dissenters included Governor King, who had cast hawkish dissenting votes with three other members in August 2005 and June 2007 and arch-hawk Tim Besley, who had wanted a tighter policy than the majority at seven previous meetings.  These were not objections from perennial policy doves and therefore send a signal that it will be a long time indeed before the bias of policy switches direction.

Coming into the August meeting, speculation had arisen that the Bank of England would be one of the first central banks to tighten its stance.  Markets were certainly not expecting the Bank of England to ease because numerous recent indicators have shown greater economic life than assumed.

  • The Halifax and Nationwide house price indices recorded monthly increases and smaller on-year declines.
  • The latest manufacturing and service PMI readings were each above 50 for the first time since April 2008.  Like other diffusion indices, a score of 50 or above connotes expanding activity.  They have respectively recovered by 16.3 and 13.1 points.  Meanwhile, a 47 score on the construction PMI was at a 16-month high.
  • Gross mortgage lending reported by the Council of Mortgage Lenders has recovered to the best level since last October.
  • New car sales rose in July for the first time in 15 months.
  • Same store sales and total retail sales reported by the British Retail Consortium substantially surpassed expectations in July.  The government’s retail sales release earlier today corroborated that finding.  Retail sales volume rose 4.9% at a seasonally adjusted annual rate in the three months to July against the level in February-April.
  • The CBI’s corporate survey depicts a stabilizing trend.

These green shoots are alas only part of the story.  Britain was hammered worse than most economies.  Even in 2Q09 when Germany, France, Portugal, Greece, and the Czech Republic reported positive growth, British GDP sank 3.2% at a seasonally adjusted annual rate and recorded a whopping drop of 5.6% from the second quarter of 2008.  Monetary policymakers know that inflation responds to the level of activity, not its rate of growth, and the British economy has loads of unused slack.  The jobless rate of 7.8% compares to 5.4% a year earlier.  Wage growth of 2.5% is a full two percentage points below the comfort ceiling of officials.  Producer output prices fell 1.3% in the latest reported statement year, the most since November 2001, and producer input prices have dropped 12.2% from a year ago.  These data say more about where CPI inflation is headed than the CPI itself, which remains at 1.8%, not dropping as quickly as in many other economies.

Minutes from the August policy meeting conclude that if inflation will not climb back to target within two years if monetary policy settings match what the market is expecting.  Concern is expressed that money growth hasn’t accelerated in the way officials had hoped, and officials perceive greater potential damage from a policy now that is not accommodative enough — for example, expected inflation might drop too low or hopes for recovery would be dashed — than if the credit stance is set too loosely.

Since meeting on August 6th, sterling has depreciated 2.8% against the dollar and fallen also against the euro.  Ten-year gilt yields have decreased 23 basis points despite the awful state of British public finances where debt has climbed over 21 percentage points in the past two years to 56.8% of GDP.  The Ftse is now 2.4% firmer.  Bank of England officials can live with these results.

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



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