Bank of England Preview: No Changes This Time
January 6, 2010
British monetary policy is on hold until at least February and possibly beyond midyear. The last base rate cut occurred in March 2009 and culminated 450 basis points of reduction from 5.0% to 0.5% squeezed into five months. Additional easing since then has been engineered via quantitative purchases of assets, mostly gilts, that will reach Gbp 200 billion in size or over 10% of GDP by end-month. The last boost in quantitative easing was made in November and was synchronized with the central bank’s quarterly inflation report. Minutes from the December 10 meeting, where the vote of policy-makers was unanimous at 9-0, make it clear that a decision to stop asset buying or extend the program further will not be made until February and will be contingent on future developments.
Nothing over the past four weeks was sufficiently significant or clear-cut to warrant an announcement about quantitative easing before the February meeting. The rising yield on gilts, a concern in the December minutes, has continued with such advancing another 35 basis points to 4.02%. The trade-weighted pound has not changed much, as modest appreciation against the euro has offset the impact of depreciation against the dollar. The Ftse, like other European equities, improved with a rise of over 5%. Oil is significantly firmer. The December minutes talked about uncertainty surrounding prospects for economic recovery, which is the baseline forecast.
True to form, there has been good as well as disappointing economic data released since the Monetary Policy Committee last met. Some of the best news came with this week’s PMI releases, which saw the manufacturing index climb to 54.1 in December from 51.8 in November and the services reading hold at 56.8 after 56.6 in November and 56.9 in October. Also, the contraction of GDP in the third quarter of 2003 was revised downward to 0.2%. Final domestic demand growth swung into the black but was still counter-balanced by negative contributions from inventories and net exports. Personal consumption in the quarter grew by a weak 0.1% and continued to flounder in 4Q despite November’s first drop in unemployment since February 2008. Real retail sales in November fell 0.3%, the worst result in a half year, and both the GFK and Nationwide gauges of consumer confidence showed worsening trends in their last release. The last monthly survey of retailers done by the CBI was awful, too.
British exports have not done as well as hoped considering the pound’s erosion during the financial crisis, and money growth continues to be weak and pretty impervious to the Bank of England’s massive quantitative easing. At this point, a majority of analysts believe that the Bank of England will stop quantitative easing next month, but that view is not held with very strong conviction and could change depending on what emerges over the rest of January. Britain has many negatives: the terrible shape of public finances, an over-reliance on financial services, negative growth last summer when positive growth had already returned to Euroland, United States, and much of Asia. Real GDP rose merely 0.5% in 2008 and probably fell over 4.0% in 2009. On-year growth in 3Q09 was negative 5.1%. Yet inflation never slipped under zero. The 12-month rise of the CPI accelerated from 1.1% in September to 1.9% in November, and the core rate of consumer price inflation was also at 1.9% in the latest month. Bank of England officials have a treacherous balancing act ahead of them in a year that is also fraught with political uncertainty. It would be the shock of shocks if the Conservatives fail to end the 13-year reign of the Labour Party and just about as surprising if the Tories do not raise VAT when they come to power. Doing that will have a knock-on impact on CPI inflation.
Monetary officials cannot put inflation to one side, even if they might like to do so in light of the slack in their economy. Indeed, the last inflation report puts inflation above target in the medium term if policy were to remain as it stands currently. Unless measures of economic activity surprise significantly and surprisingly to the downside, it will be very hard to justify further quantitative easing in February. Some time beyond that inflection point will be open discussion by officials about an exit strategy and eventual implementation of such as other central banks are already doing.
Copyright Larry Greenberg 2010. All rights reserved. No secondary distribution without express permission.
Tags: Bank of England, Britain, exit strategy
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Is there a way for the pound to recover? Most other countries seem to be coming out of the recession. I suppose if the pound drops to $1.50,
we will all go there on vacations in tead of going to Poland.