Bank of England to confront growth vs. inflation dilemma after end of QE

By David Milliken, Reuters

LONDON — The Bank of England (BOE) looks set to call time on its asset-buying program next week, judging that it cannot afford to ignore Britain’s sticky, above-target inflation even though official data shows the country is back in recession. The decision to end so-called quantitative easing, or QE, is unlikely to be welcomed by Britain’s Conservative-led coalition, which was battered in local elections on Thursday, and has relied on loose monetary policy to soften the pain from of austerity aimed at reducing Britain’s massive public borrowing. After buying 325 billion pounds (US$527 billion) of government debt with newly created money — 50 billion pounds of which was purchased in the last three months — the BOE is likely to judge that its policy stance is already supportive enough. Gnawing at members of the BOE’s nine-strong Monetary Policy Committee is the worry that they might have miscalculated when they forecast in February and earlier that inflation would be below their 2 percent target by the end of 2012. Inflation unexpectedly rose for the first time in six months in March, touching 3.5 percent, the highest rate in the Group of Seven major advanced economies. This leaves first-quarter inflation above the 3.35 percent forecast in February, making the expected fall to an average 3 percent in the second quarter more challenging. An upward revision to the bank’s quarterly inflation forecasts is likely later this month. “They’re going to end up with an inflation profile that is substantially higher in the short-term,” said Jens Larsen, a former BOE economist who now works at RBC. “The notion that there will be a significant undershoot is hard to believe.”

A below-target forecast for inflation two or three years ahead was the formal justification for the BOE to start a second round of QE in October. In practice, worries about the euro zone debt crisis and weak growth drove the decision. Official data last week showing that Britain’s economy shrank 0.2 percent in the first three months of 2012 after a 0.3 percent decline at the end of 2011 might suggest these worries have not gone away. But in minutes to its April policy meeting, the BOE said it was likely to overlook weak GDP data in the short-term as it believed that upbeat business surveys were more representative of the true health of the economy. BOE Governor Mervyn King noted that inflation was “high” and that recovery was in view during the past week. Deputy governor Paul Tucker and external member Adam Posen — who was formerly a leading proponent of QE — both made public statements indicating that more QE was unlikely. Only five of the 58 economists polled by Reuters earlier this week expect the BOE to approve further QE. However, a surprise cannot be completely ruled out. MPC member Martin Weale said that the weak GDP data — which came out after the minutes — had strengthened the case for QE, and David Miles has suggested his supportive view remains intact.