Bank of England Preview: Between a Rock and a Hard Place

May 9, 2012

The term stagflation applies to Britain much more accurately than to any other major industrial economy. 

  • The U.K. economy’s second recession in five years has been confirmed after GDP contracted in both 4Q11 and the first quarter of 2012, the latter by 0.8% at an annualized rate.  Only half of the calendar year GDP declines of 1.1% in 2008 and 4.4% in 2009 was reversed in 2010-11, so the new downturn started from a considerably lower level of activity than the pre-Great Recession crest.
  • British consumer prices rose at a 3.5% on-year rate between the first quarter of 2011 and first quarter of 2012.  The Bank of England targets the medium-term CPI inflation rate at 2.0%, and officials have run out of excuses to explain the now-chronic overshoot.  Consumer prices also climbed 3.5% per year between the first quarter of 2008 and the first quarter of this year.  The mandate to preserve price stability as so defined may lose credibility.

Many policymakers at the Bank of England have lost their confidence in a long-held view that inflation has run above target because of a succession of special factors and will eventually drop quite low.  As recently as February when the last quarterly Inflation Report was prepared, a strong majority of the Monetary Policy Committee was convinced that inflation would drop below the medium-term target unless more policy stimulus was introduced, and the Asset Purchase Plan was increased at that time by GBP 50 billion to its present ceiling of GBP 325 billion which was reached recently. It was believed at the start of the year that inflation would be receding appreciably during the second half of 2012, but that no longer appears highly certain.  One of the Bank’s two deputy governors thinks inflation may not go below 3.0% this year, completing three full years without a sub-3.0% reading over any 12-month interval.  The committee’s most outspokenly dovish policymaker, Adam Posen, withdrew at the April meeting his perennial dissenting vote in favor of more stimulus.  Minutes from last month’s meeting moreover revealed a consensus that inflation would be falling more slowly than assumed previously and mounting concern about the erosion of the credibility of the Bank of England’s commitment to reducing inflation.

A new quarterly Inflation Report arrives May 16, but it will not be used to justify another increase of the Asset Purchase Program.  In order for the GBP 325 billion limit to be raised now or ever, it probably will be necessary for inflation to indeed drop far more quickly and extensively and/or for Britain’s new recession to deepen sharply.  Such conditions seem doubtful.   Forecasters from the private and public sectors presently think GDP will advance slightly more than 1.5% in 2013, which is not weak enough to offset the frustration of inflation’s resistance to downside pressure.

The decision to be announced at 11:00 GMT on Thursday will not include additional commentary explaining why neither the 0.5% Bank Rate nor the Asset Purchase Plan’s size is being changed.  The preference when not changing policy is to let other vehicles perform that function, the quarterly Inflation Report on May 16, and the minutes from this week’s meeting that arrive on May 23.  Many analysts expect those documents to more formally reset future policy guidance to balanced risk between ease and restraint rather than the easing bias shown up until now.  However, one should not also look for hints of outright interest rate cuts or lessening quantitative easing to occur soon.  Officials are indeed stuck between the rock of greater inflationary risk and the hard place of economic recession.  All that can be done for the time being is to hunker down, keep the current stance, and hope for the best.  It may even be necessary to provide some explicit indication, as Draghi did last week, that any talk now of the onset of tightening would be premature.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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