Bank of England Quarterly Inflation Report

February 10, 2010

On a day when the Fed released a testimonial statement of what Chairman Bernanke had planned to announce about how the policy stance will be reined in, the Bank of England’s published quarterly Inflation Report pointed to a considerably more delayed policy reversal in Britain.

British monetary officials revised projected GDP growth in the year to 2Q11 to 3.2% from 4.0%, identified persistent considerable slack remaining in the U.K. economy that will depress on-year CPI inflation to 0.9% by early 2011, and said inflation probably will stay below 2.0% over the balance of the forecasting horizon.  The report calls the risks to the inflation outlook “balanced” but “significant” in either direction.  If the chips fall on the downside, that statement implies a swing of on-year inflation to below zero.  Viewed from that standpoint, it’s not at all surprising that officials would not today rule out the possibility of having to resume gilt purchases in the future.  And it goes without saying on their part that there is presently no urgency to start an exit strategy as other central banks are doing.

Three growth supports but two headwinds are identified.  The supports are 1) substantial monetary stimulus embodied in the present stance, 2) a global recovery, and 3) past sterling depreciation.  The constraints on growth will be 1)restrictive credit market conditions and 2) a significant fiscal consolidation that lies ahead.  Among the stimulants, the impact of monetary stimulus will lessen.  Monetary policy can be measured by both its level, which is very loose, and its change, which has stopped.  This has been a problem in Japan, where the overnight target rate of 0.1% is as low as anybody’s but where the net fall in the rate during the Great Recession amounted to merely 40 basis points, which is stingy compared to what other central banks did.

Today’s Bank of England report figuratively, although not literally, invites investors to bid the bound lower.  Sterling depreciation is one of three pillars upon which a recovery of GDP will be based.  In spite of the pound’s drop, inflation is projected to remain below the 2% target and could even dip to zero or below, so no inflationary risk will be associated with further exchange rate loss.  The way to still loosen British monetary conditions if asset sales are not resumed would be through a weakening pound.  Finally, since fiscal policy must tighten, the burden lies entirely on monetary policy to make sure that a fragile recovery doesn’t flame out.  This final point has applications for other central banks in Europe like the ECB as well as for the Fed, and it argues in favor greater caution in reversing present loose monetary policy stances.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.



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