With Jean-Claude Trichet warning that the debt crisis lights are flashing red and Ben Bernanke telling investors the US slowdown is temporary, but could have longer lasting effects, Mervyn King at the Bank of England is discussing pumping more money into the UK economy.
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Big Ben
Minutes from the last meeting of the BoE’s monetary policy committee showed that despite two members wanting to hike rates, others are considering another round of quantitative easing.
“For some of these members, it was possible that further asset purchases might become warranted if the downside risks to medium-term inflation materialized” said the statement from the Bank of England.
The biggest concern for the UK central bank's policy committee appears to be the lack of consumer spending that has led to uncertainty over the level of spare capacity in the economy and the subsequent direction of inflationary pressures.
Stephen Lewis, the chief economist at Monument Securities believes this uncertainty leaves Mervyn King and his team in a difficult position.
“It is supposedly what the MPC wants to see as the chief element in a rebalancing of the UK economy away from domestic demand towards net exports,” said Lewis in a research note.
“If the MPC were to revert to its pre-2007 strategy of pumping up the economy whenever domestic demand falls below the trajectory that the Bank’s forecasting equations indicate as consistent with achieving the inflation target, its action would tend to frustrate the necessary rebalancing,” said Lewis.
Inflation Greater Challenge
Given the UK has historically had to fight inflation rather than worry about falling prices, Lewis questions if deflation could be a real threat.
“In Rip-off Britain, where price gouging is not unknown, central bankers have, in fact, experienced much more testing challenges in containing inflation than in heading off deflation,” he said.
Risks to the UK come from both sides of the Atlantic. The US slowdown and Greek debt crisis have intensified since the BoE last met and this is causing concerns.
“Since the June MPC meeting, the scale of these worries has, if anything, grown with the Greek government’s next bailout tranche still balanced on a knife edge as it battles to pass austerity measures," Victoria Cadman, an analyst at Investec in a research note following the BoE minutes.
"The run of US data has, on the whole, also continued to soften throughout the month,” Cadman said.
With a number of factors clouding the UK growth picture Cadman said it will take time for the true health of the British economy to become clear.
"The likely, but as yet undefined in size, drag to second quarter growth resulting from the Royal Wedding holiday, the increase in oil prices earlier this year, and supply chain disruptions from the Japanese tsunami, complicate the committee’s assessment considerably,” she wrote.
With austerity measures weighing on sentiment for Britain’s millions of public sector workers and strikes on the way there will be little help for the UK economy from Chancellor George Osborne who consistently said there is no plan B on attempting to reduce the deficit.
Despite this uncertainty Cadman sees little chance of the quantitative easing debate at the BoE being anything more than a debate.
“Our central view however is for a return to somewhat more robust UK and US growth in the third quarter of this year. We therefore consider that while the committee may be happy to add the prospect of QE more centrally back into its policy debate, the prospect of further QE remains unlikely,” she explained.
Like Cadman, Lewis can see little reason for pumping more money into the system on monetary policy grounds but questions if the motivation for debating more QE could be the banks, not the consumers.
“They would not easily justify such action on monetary grounds. As the minutes state, nominal consumption has continued to rise at a substantial rate, albeit largely on account of inflation, despite weakness in broad money growth,” Lewis wrote.
“There are no surprises there, since only the crudest of monetarists would look for a close correlation. MPC members, though, seem to be turning their attention to problems of banks’ capital-raising, where QE is widely regarded to have been helpful in the past,” he added.
