-BOE Aug Inflation Report Shows Marginal Changes To CPI Forecasts
-BOE King Downplays Case For A Cut In Bank Rate
LONDON (MNI) – The little changed inflation projections in the Bank
of England’s August Inflation Report showed CPI coming in markedly under
target but Governor Mervyn King made clear monetary policy was unlikely
to be loosened further in coming months and he poured cold water on a
Bank Rate cut.
The forecast inflation undershoot leaves the door open to further
quantitative easing but King said the report did not indicate urgent
action was needed. Expectations of a near-term Bank Rate cut were
slashed in the wake of his comments with more QE in November looking the
most likely option if the BOE decides to ease policy further.
Some economists had forecast sharp cuts in the Inflation Report
projections in comparison to May, reflecting lower commodity prices and
a deterioration in the growth outlook. Others, however, highlighted the
offsetting factors: the extra stimulus the BOE had sanctioned in recent
months and the growing loss of faith at the central bank that there is a
large margin of domestic spare capacity pulling down on inflation.
In the event, the upside and downside effects pretty much cancelled
each other out.
The two year ahead CPI forecast was nudged up to close to 1.7% from
just under 1.6% in May. The probability of CPI overshooting its 2.0%
target two years out, however, was nudged down to somewhere just over
40% from 43% in May.
The shifts are of little significance with the broader picture one
of inflation a little more likely than not to undershoot its target but
with the MPC waiting to see what the impact of its credit easing
measures will be.
King rejected the view the August report supported further stimulus
now.
“Towards the end of the forecast horizon the balance of risks to
inflation around the 2% target is broadly balanced. That in itself does
not suggest an urgent need for further action,” King said.
The BOE, along with the Treasury, has backed a raft of credit
easing measures, with the Stg80 billion Funding for Lending scheme the
showpiece. King made clear the MPC wants to wait to get a clearer view
of the impact these will have before deciding on its next policy step.
“When we met last week, we had already put in place an additional
set of asset purchases, another 50 billion and the Funding for Lending
Scheme is only a week old today. So I think we do need a bit of time to
see how they will work,” he said.
Nevertheless, the door remains wide open to further QE down the
line.
“There are measures we can take in the future and further asset
purchases will clearly be one of them. That is something we will look at
each month as we come to it, without prejudging what the appropriate
response will be,” King said.
The surprise for money markets came in King’s skepticism over the
case for a Bank Rate cut. The MPC has long held the view that a Bank
Rate cut could be ineffective, if not counter productive, as it may end
up squeezing banks’ margins as they are highly unlikely to cut deposit
rates to zero.
With the IMF, however, urging it to look again at the case for a
cut, the MPC did discuss one at its June and July meetings and decided
against one.
The July minutes, however, suggested a cut in Bank Rate could be
warranted in future as the FLS drove down funding costs and this helped
solidify market expectations a cut was on its way this year.
“The impact of the FLS and other policy initiatives might, in time,
alter the Committee’s assessment of the effectiveness of such a rate
reduction,” the minutes said.
King, however, when asked if a Bank Rate cut could be counter
productive expressed sympathy with this view.
Cutting bank rate “would damage some financial institutions and it
would, therefore, in all probability have an element of it being
counter-productive which is precisely why we haven’t cut Bank Rate,” he
said.
“In the minutes of the last (July) meeting we did discuss it but we
concluded for the time being that we thought it would be more
counter-productive than beneficial which is why I don’t think it is
something we would contemplate doing immediately,” he said.
He made clear a cut of 25 basis points in Bank Rate, at a time when
QE totals Stg375 billion, would be of little significance.
“To some extent it’s neither here nor there, another quarter point
off Bank Rate is not going to be the difference between having a
recovery and not having a recovery,” he said.
Prior to the Inflation Report money markets were, on a rough
measure based on SONIA, pricing in an 80% chance of a cut in Bank Rate
and after King’s comments this slid to 50%.
The report also shows the MPC becoming increasingly skeptical about
the idea that slack in the domestic economy, which should in theory be
widening with the economy contracting according to official data, will
create substantial downward pressure on inflation.
The problem is supply growth appears to have been exceptionally
weak during the attempted recoveries from the recession, with both
possibly hit by credit constraints.
“The weakness in demand growth in recent years appears to have been
accompanied by below par supply growth … The likelihood that
developments in supply and demand will continue to be closely associated
suggests that some of the sources of uncertainty affecting the outlook
for growth may have only limited implications for spare capacity and
hence inflation,” the report said.
The August Inflation Report and King’s comments show the MPC
downplaying the impact of the latest downturn in the official growth
data, arguing the 0.7% contraction on the quarter in Q2 exaggerated
economic weakness, and expressing skepticism over the view that it will
result in any meaningful widening of spare capacity.
All this suggests the MPC is unlikely, unless things take a severe
turn for the worse, to slash its inflation forecasts in its next
Inflation Report in November either.
The door is open to more QE but analysts are only predicting
another Stg50 billion tranche, with a diminished chance of a Bank Rate
cut.
–London newsroom: 4420 7862 7491; email:
dthomas@marketnews.com/drobinson@marketnews.com
[TOPICS: M$$BE$]