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Bank of England Faces Knife-Edge Decision on Bond Buys

Wednesday, 6 Mar 2013 | 7:26 PM ET
Bank of England building facade in City of London
Andrew Holt | Photographer's Choice | Getty Images
Bank of England building facade in City of London

The Bank of England will make clearer on Thursday where its priorities for nursing Britain's ailing economy lie, with opinion split evenly on whether it will unveil another round of bond buying after a policy meeting.

In the past week, dismal data on bank lending and manufacturing has been accompanied by a softening of rhetoric from the central bank, and a willingness to consider new and unconventional policy options to kickstart growth - despite the fact that inflation remains well above target.

A Reuters poll of economists last week showed a 40 percent chance of the bank opting for more quantitative easing after this week's two-day policy meeting, and a 60 percent chance before the year is out.

(CNBC Poll: Should the Bank of England Expand QE?)

Since that poll was conducted, several economists have changed their call and money markets suggest that the probability is closer to 50 percent. The rise in QE expectations has weighed on the pound, pushing it to a 2-1/2 year low against the dollar.

"It's a very close call," said Ross Walker, UK economist at RBS.

"My view is that they will hold fire this month, but at the very least you have to say that the BoE is very happy to sound dovish."

Britain's central bank has already bought 375 billion pounds of gilts, the equivalent of 26 percent of national income, far outstripping the Federal Reserve's QE effort which accounts for 14 percent.

Despite the BoE's efforts to stimulate the economy via printing money, Britain is in danger of tipping into its third recession in four years and skepticism is growing about what more of the same would achieve.

(Read More: Bank of England Chief Calls for RBS Break-Up)

The British Chambers of Commerce, which downgraded its growth forecasts on Thursday, said fiscal policy, and targeted measures to support business investment, would be more effective than pushing monetary policy further into already charted waters.

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"More QE would only provide marginal benefits for the economy, while heightening longer-term risks of financial distortions, bubbles and higher inflation," said BCC economist David Kern.

Pushing on a Piece of String

BoE policymakers do not seem to share those qualms, however. While they believe interest rates, at 0.5 percent, have gone as low as they can, they believe QE still has some mileage left.

Deputy governor Paul Tucker, who did not vote for more bond buying in February, said last week that "nobody on the committee thinks that QE has reached the end of the road and that it is not a useful instrument anymore".

(Read More: Poll: Should the Bank of England Expand QE?)

Minutes to last month's meeting showed three of the bank's nine monetary policy committee members were already convinced of the need for more QE.

The fact that Governor Mervyn King was among them is significant. The last time he was in the minority was last June and the following month he got his way.

King will be replaced in July by Bank of Canada Governor Mark Carney, who is expected to take a proactive approach to getting Britain's economy growing again.

The Financial Times reported on Thursday that finance minister George Osborne would announce new powers for Carney and the Bank of England at his March 20 budget statement, though the paper did not cite sources or specify what the powers would be.

A finance ministry spokeswoman declined to comment on the FT article.

Osborne said publicly in December that he would welcome a debate on the central bank's remit. Although he added that the bar to change would be high, some economists see a chance of minor adjustments to give the bank extra leeway over how long it allows inflation to overshoot 2 percent target.

Those arguing against further stimulus already point to Britain's sticky inflation which is currently at 2.7 percent and not expected to return to target until early 2016.

(Read More: Bank of England Hints at Radical Growth Ideas)

The pound has fallen 6 percent on a trade-weighted index since the start of the year, meaning higher import costs will only exacerbate price pressures.

So far, BoE policymakers appear to be comfortable with the currency's weakness. Indeed, some economists suspect that their willingness to talk about unconventional policy stimulus may be a deliberate attempt to talk the currency lower and gain competitive advantage.

Tucker raised the idea last week of the BoE charging banks to park money at the central bank, something that could spur them to lend more to companies in an attempt to boost growth.