By David Robinson
LONDON (MNI), Feb 2 – The Bank of England’s Monetary Policy
Committee looks set to sanction less quantitative easing at its February
meeting than its own central inflation forecasts will imply is needed.
The BOE’s February Inflation Report forecasts are very likely to be
similar to November’s, which showed inflation undershooting the 2%
target by a wide margin, but few analysts expect the MPC to sanction
enough QE this month to close the gap. Recent comments by MPC members
have undermined the belief the committee is set on aggressive policy
easing.
The problems of translating the BOE’s central inflation projections
into the MPC’s policy setting have repeatedly created confusion among
analysts and have led to some sharp criticism of the bank’s
communications policy.
MPC members, in turn, have stressed that analysts should not focus
on the Inflation Report’s central projections but rather look at the
whole spectrum of risks, even those excluded from the central forecast,
such as risks from the Eurozone banking sector.
The November Inflation Report forecast’s central projection showed
that, even factoring in the further Stg75 billion of QE the MPC approved
in October, CPI on the central, modal projection was set to fall to
1.27% by Q4 2013 and to nudge up to just 1.32% by the first quarter of
2014 – which will be the February report’s two-year forecast horizon.
MPC member Ben Broadbent, in a recent interview with Market News
International, highlighted why there is no easy read across from the
headline inflation forecast to policy.
While the November forecasts did show that even after the Stg75
billion of QE the balance of risks was for below target inflation “even
that doesn’t pre-determine anything (on policy),” Broadbent said.
There is an MPC line “that has been trotted out so often that
people can be forgiven for discounting it, but they shouldn’t. This is a
forecast of the entire distribution of risks,” Broadbent said.
“If you chose to take the modal, or the mean, number it is true
that it is below that 2% target. But the extent to which it is below is
small relative to the degree of uncertainty in the forecasts and even
smaller relative to the distance we have to travel in the interim,”
Broadbent said.
Another wrinkle is that risks that are not even included in the
central forecasts can influence policy. When the MPC sanctioned the
extra Stg75 billion of QE back in October, fears were high that the
Eurozone banking system could freeze up, with intrabank funding under
intense pressure due to the heightened risk of bank failures.
On December 21, the European Central Bank stepped in with a E489.19
billion longer term refinancing operation, which has eased pressure
considerably on the Eurozone banking system and bank funding has
improved markedly in January.
The ECB’s LTRO “certainly removes for a reasonable length of time
some of the downside risks and makes things better,” MPC member Adam
Posen told reporters last week.
“The near term risks, and in particular the risks that this whole
thing would be amplified by some bank failure in Europe, have reduced,”
Broadbent said.
The MPC, in its November forecast round, explicitly excluded the
Eurozone financial risks from its central forecast, saying they could
not be meaningfully quantified. Broadbent says it would be a mistake to
assume from this they will never influence policy.
“It might change policy, it would change policy all the same.
Because policy is based on our assessment of the overall risk, however
difficult that is to quantify,” Broadbent said.
“Those risks diminishing does matter, absolutely” he added.
The MPC looks set to exclude the, now diminished, Eurozone banking
risks from its February forecast as well.
“I wouldn’t be surprised if we did the same thing again, quite
honestly,” Broadbent said.
The Bank of England recently issued a set of working papers on the
impact of quantitative easing. These provide analysts with “ready
reckoners” to work out the impact of any given quantity of QE on
headline inflation.
One BOE estimate showed the first wave of QE, the purchase of
Stg200 billion of assets, had “a peak effect on annual CPI inflation of
about 1.25 percentage points.”
Another, monetarist model, showed an impact of around 1% on CPI a
year after its peak impact in growth. Plug in the first, 1.25 pp CPI
peak impact assumption, and another Stg100 billion of QE would add
0.625pp to CPI.
At face value, that would imply if the MPC’s February inflation
forecasts are similar to November’s, the committee should be debating
Stg100 billion of QE to close the CPI undershoot, while a case could be
made for “just” Stg75 billion.
Analysts’ current forecasts, however, centre on the MPC approving
Stg50 billion of QE at the February meeting, and economists predicting
Stg75 billion highlight the risk the committee will do less in light of
recent MPC comments.
Malcolm Barr, economist at JP Morgan, says that based on the
November Inflation Report projections their central call was for Stg75
billion of further QE in February, but there is uncertainty around this,
less due to the likelihood of any substantive change in the February
inflation forecasts but more from how the MPC responds to them.
Barr points out the November balance of risks showed a 43%
probability of CPI below 1% two years ahead, and just a 12% chance of it
above 3%. Despite the forecasts showing the risks far from balanced
around the target, the MPC has so far stuck with the Stg75 billion of QE
it approved in October.
Even arch MPC dove Posen has downplayed the likelihood of the MPC
approving another huge tranche of QE, unless things really deteriorate.
Asked about the amount of QE Posen told reporters “there was no
point doing anything less than Stg50 billion and if doing Stg175 billion
was enough in the worst of the crisis it is probably reasonable that we
are doing less than that now.”
As the MPC has already approved Stg75 billion in the second wave of
QE, another Stg100 billion would take it up to Stg175 billion, which
would match the amount the MPC Posen’s notes was approved at the peak of
the financial crisis, and contradict his view it is “reasonable” to be
debating less.
When the Inflation Report is published on Feb 15, if the MPC has
sanctioned, say, Stg50 billion or even less of QE at the month’s
meeting, which ends Feb 9, BOE Governor Mervyn King and colleagues will
again face the challenge of explaining to MPC watchers how to reconcile
its forecasts and its policies.
The line that the MPC is not in the business of “fine tuning”
policy will surely be used again.
The MPC was “at pains in the (November) minutes …. and
subsequently to point out that we are not really in the business, even
if we ever were, of policy fine-tuning,” Broadbent said.
–London Bureau; Tel: +44207 862 7491; e-mail:
drobinson@marketnews.com
[TOPICS: M$$BE$,M$B$$$]