Bank of England Decision Still Fairly Evenly Balanced

November 3, 2010

Why would the Bank of England even consider increasing its asset purchase program after learning that real GDP in the third quarter expanded 2.8% at an annualized rate with equally positive contributions from the production and services sectors?  Moreover, the purchasing managers indices for manufacturing (up 1.4 points to 54.9 in October) and services (up 0.4 points to 53.2) conveyed stronger activity than expected.

The temptation to stimulate further lies in other data and developments.  Construction growth is weakening after a buoyant summer quarter.  Mortgage approvals are lower, and both the Nationwide and Hometrack house price indices posted month-on-month declines in October.  Retail sales slid 0.2% in September.  The CBI October monthly surveys registered a drop of 11 points to minus 28 for industrial trends and 13 points to +36 among retailers.  Consumer confidence has drifted lower.  On-year M4 growth of 1.0% in September was at a record low.  The tea party is about to begin in Britain, the object of the original tea party protest in Boston, and the fiscal medicine will be massive and sustained.  The U.K. value added tax goes up to 20% from 17.5%  in January, and program spending on everything but health and foreign aid will collectively decline by 19% per annum over the coming four years.

The Monetary Policy Committee split three ways at the October meeting.  A majority of seven members agreed to make no changes, but some in the majority perceived a rising medium term risk that more monetary stimulus would be required eventually, or inflation would move and stay below its target of 2%.  Andrew Sentance again dissented, making a case for lifting the Bank Rate by 25 basis points to 0.75% and observing that the hike in VAT will in the near term keep CPI inflation above 3% and perhaps knock expected inflation upward.  Adam Posen, on the other hand, observed that expected inflation and wages remain subdued and wanted to increase the asset purchase limit from the current GBP 200 billion to GBP 250 billion.  Minutes from the October meeting suggest a very fluid and diverse array of opinions.  Just as the ECB likes to synchronize policy modifications with quarterly forecasts that are made in the final month of each quarter, the Bank of England prefers to change policy in those months (February, May, August, and November) when its inflation reports get published.  If the policy committee defers a policy change now because of insufficient evidence that such is needed, the delay likely would mean not acting until at least February.

My sense is that markets are positioned for no more quantitative easing just yet — not by a big margin but enough to suggest a greater market response if officials do announce more stimulus on Thursday than if they do not.  Sterling, which previously had depreciated, is unchanged on balance in trade-weighted terms from October 7 when policymakers last conferred.  The Base Rate has been at at 0.5% since March 2009, having previously been slashed from 5.0% as of the end of 3Q08.  GBP 200 billion of asset buying were done between March 2009 and January 2010.

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



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