Bank of England Preview: Shifting Risks

February 9, 2011

The smart money, which says the Monetary Policy Committee will again elect not to change policy settings, may be whistling past the cemetery.  Resistance to a bank rate hike of 25 basis points to 0.75% is diminishing.  Minutes from the January 13th meeting revealed lessening comfort with the current policy stance:

  • Two of nine committee members dissenting in favor of a rate hike as Martin Weale joined perennial hawk Andrew Sentance in that view.
  • The majority agreeing that medium-term inflation risks had increased, a group that appears to include chief economist Charles Bean.  Policymakers cited commodity prices, sterling’s vulnerability and imported inflation from emerging markets as potential dangers.
  • Perennial dove Adam Posen again cast a dissenting vote in favor of renewed asset buying but conceded less confidence than before in the likelihood of sub-target inflation in the medium term.
  • Mounting fears about rising inflation expectations if policymakers don’t react to excess inflation.  In one case, the Bank of England’s whole credibility as an inflation fighter is on the line.
  • The main argument against tightening in January was that such might be misinterpreted and thereby depress sentiment and economic activity.  It was agreed that a Bank Rate of 0.75% would still represent a quite accommodative stance.  Officials agreed that a better assessment of the appropriate policy stance could be made in February when a quarterly inflation report will be prepared.

Inflation indicators released since the January meeting show an additional loss of price stability.  CPI inflation has been 3.0% or higher for the past 13 months and advanced to 3.7% in January from 3.3% in December.  The 1.0% CPI increase between December and January was the biggest monthly advance in at least 15 years.  Food price inflation of 6.1% is the most in twenty months and a prime factor behind accelerating overall inflation.  However, all advanced nations are struggling with food price pressures because of the global prevalence of extreme weather, but other nations don’t have Britain’s high level of total inflation.  Producer output prices climbed 0.5% and 4.2% on year in December, more than forecast.  Producer input inflation likewise jumped 3.4% and 12.5% on year.  The claimant count of unemployment fell every month last quarter.  Shop price inflation accelerated by 0.4 percentage points in January.

Indications of activity released over the past four weeks have been mixed.  The biggest negative shocker was that real GDP had contracted 0.5% last quarter, or 2.0% at an annualized rate.  Housing market data — prices, borrowing and activity — continue to show weakness, too, and consumer confidence sank to a 22-month low of minus 29 in January when value added taxes rose by 2.5 percentage points from minus 21 in January.  The industrial trends survey weakened to minus 16 from minus 3 in December, and the retailer survey showed a 19-point drop to +37.  The British deficit on goods and services trade widened to GBP 4.83 billion in December from average deficits of GBP 3.93 billion in October-November and GBP 4.26 billion in the third quarter of 2010.  The goods-only deficit shot above 9 billion pounds to GBP 9.25 billion in the final month of the year.

On the other hand, retail sales rose 1.4% (not annualized) in 4Q10.  The manufacturing purchasing managers index improved 3.3 points to a record high of 62.0 last month.  The construction PMI rose 4.6 points to 53.7, surpassing December’s weather-depressed 49.1 but also November’s reading of 51.8.  The services PMI advanced 4.8 points to 54.5 and likewise also surpassed November’s level as well as December’s

Compared to January 13 when policymakers last met, the pound is stronger against the dollar and in trade-weighted terms.  Equities have strengthened slightly, and the 10-year gilt yield has increased around 20 basis points.  Minutes of Thursday’s meeting will not be released until February 23.  Most times when policy is left unchanged, which is the expectation of market players, the announcement of policy action due 12:00 GMT Thursday only tells the facts, deferring any explanation of thinking to the minutes.  But when officials feel compelled to be particularly transparent with the market, they on seldom occasions release a lengthier statement.  One has to wonder if this might be one of those times.

Copyright Larry Greenberg 2011.  All rights reserved.  No secondary distribution without express permission.



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