–Dovish Posen, Hawkish Sentance, MPC Majority Seen Unmoved
–Ireland, EMU Contagion Adds To Case For Continued Accommodation
–Austerity Impact In Early 2011 Likely Key To Next Policy Steps
LONDON (MNI) – Given the latest signs that the moderate UK
economic recovery remains steadily on track going into the fourth
quarter, there seems little cause for the majority of the Bank of
England Monetary Policy Committee to come down off the fence
at the December policy meeting which will conclude at midday Thursday.
The latest industrial/manufacturing output data along with the
latest PMI and business surveys point to a surprisingly strong
manufacturing/export sector, while service sector growth slows
somewhat and construction starts to come off the boil.
Housing and credit remain a weak spot in this overall picture, yet
that suits the MPC’s wish to see a ‘rebalancing’ of the UK economy away
from domestic demand and towards net exports and investment.
Cost and inflation pressures remain high and there have been signs
of inflation expectations starting to drift up in the surveys, but
little prospect of these getting passed into a secondary round of wage
and price hikes, given subdued pay and demand growth.
BOE Chief Economist Spencer Dale words in a keynote text last week
sums up the majority view on how policy should be conducted on the
committee:
“If a significant degree of spare capacity persists in the medium
term, inflation is likely to fall below target. The current focus of
monetary policy is on providing the stimulus necessary to support the
recovery so the degree of spare capacity in our economy is gradually
reduced. That is critical if we are to hit the inflation target in the
medium term”.
The approach was implicit in the BOE’s late Inflation Report, which
stressed that the committee saw inflation as likely above as below the
target by the end of the 3-year forecast and more likely to be below it
at the two-year point, although with the risks on the latter skewed to
the upside, spelling out the economic case for policy stand still.
The forecast was on market expectations of only a very gradual
tightening in policy beginning late 2011 and underlined the high degree
of uncertainty among MPC policymakers.
The committee is notoriously wary of changing policy in
non-Inflation Report months and, given that the subsequent data flow has
been in line with the BOE’s November scenario, a move to either tighten
Bank Rate or hike QE seems to be very much off the menu.
Governor Mervyn King and other BOE insiders have noted that the
policy debate inside the MPC is “vigorous” but the fact the discussion
has two very public lightning conductors in the form of the
hawkish Andrew Sentance and the doveish Adam Posen has helped stabilise
market and public expectations.
Andrew Sentance looks set to stick with his campaign for a 25 basis
point rate hike at this meeting, certainly what new data there has been
conforms with his view that recovery is on well on track and is
benefiting from stronger than appreciated global growth.
The doveish Adam Posen has also made clear that it will take more
than a quarter or two of relatively positive activity data to undermine
his view that more quantitative easing at the least will be needed.
The upside surprise of Q3 GDP seemed to put QE2 out of mind
following the Inflation Report and the minutes for the November meeting.
The MPC even seemed to err in a mildly hawkish direction in the latter
document.
The latest Irish twist in the euro crisis and the threat of further
contagion in the EMU peripherals seemed enough to get King talking about
the possibility of QE2 when he met with the Treasury Select Committee in
November.
Such external shocks have tended to put the MPC on the defensive in
the past and this time seems no difference, particularly given the
threat which Ireland poses as a significant UK export destination.
As King told the Treasury Select Committee recently, “In the
Inflation Report…the projections of the MPC implied that over the next
three years growth was a little more likely to be above than below its
historical average. But there are risks, and we are particularly
dependent on prospects in the rest of the world. A healthy European
recovery is important to the ability of the UK economy to rebalance”.
The bright spot offsetting the travails of the EMU periphery in the
euro zone has been the renewed vigour of the German export machine,
which seems to be benefiting in much the same way as UK manufacturing
from a highly competitive exchange rate.
But, as austerity starts to bite in early 2011, first with the hike
in VAT and the first impact of spending cuts on the real economy,
further slowing in the pace of recovery is a real risk and further QE
could rapidly move back into the frame.
Much ink has been spilled over the recent controversy over
King’s public approval of the UK June Emergency Budget and whether he
‘crossed a line’ – but there is always an implicit if not explicit trade
off between monetary and fiscal policy.
As stated by Chancellor of the Exchequer George Osborne this
morning at the same Treasury Committee – there may be no coordination
as such between monetary and fiscal policy, but putting in place a more
ambitious fiscal stabilisation plan has offered monetary policy the
“maximum flexibility” to respond – if it is needed to stimulate demand.
As Osborne stated – the classical way of thinking about
macroeconomic policy making and its main instruments in the past 30
years has been that monetary policy has to be the “principal” tool for
fine-tuning demand.
–London bureau: +4420 78627492; email: dthomas@marketnews.com
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