BOE's Inflation Battle May Pose Headache for Cameron

The Bank of England’s battle with above-target inflation could make life difficult for Prime Minister David Cameron and his plan to cut the record budget deficit.

While economists in Bloomberg News surveys expect the central bank to leave its key interest rate and bond-purchase plan on hold today, a growing number say rising inflation expectations may force it to raise the rate within months. That would put an additional restraint on economic growth just as government cuts start to bite.

Citigroup Inc., Societe Generale SA and BNP Paribas SA said last week the Bank of England may increase the benchmark rate faster than previously anticipated to maintain credibility as price pressures intensify, while Cameron said on Jan. 9 that inflation has been “concerning.” Still, his plans for the biggest budget squeeze since World War II may depend on monetary policy continuing to support the economic recovery.

“I think an interest-rate hike would be a total disaster for the U.K. economy,” Neil Mackinnon, an economist at VTB Capital Inc. in London and a former Treasury official, said in a telephone interview. “The Bank of England trying to improve its credibility could mean the government might lose credibility.”

Photographer: Chris Ratcliffe/Bloomberg

U.K. Prime Minister David Cameron. Close

U.K. Prime Minister David Cameron.

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Photographer: Chris Ratcliffe/Bloomberg

U.K. Prime Minister David Cameron.

The pound was little changed against the dollar today and was at $1.5760 as of 7:53 a.m. in London. It rose earlier to $1.5783, the highest in almost a month.

Rate Forecasts

All 61 economists surveyed by Bloomberg predict the Bank of England will keep its key rate at a record low of 0.5 percent today. Officials will also leave the bond program at 200 billion pounds ($312 billion), according to all 39 economists in another survey. The bank will announce its decision at noon in London.

The median forecast of 44 economists in a separate survey is for the bank to raise its key rate once this year, to 0.75 percent in the fourth quarter.

The European Central Bank will keep its benchmark rate at 1 percent at a meeting of its Governing Council in Frankfurt today, a separate survey shows.

Cameron’s spending cuts are aimed at reducing a record budget deficit and preventing Britain from falling prey to the bond rout that threatened the neighboring euro area last year. Chancellor of the Exchequer George Osborne has signaled that he’s counting on Bank of England Governor Mervyn King to temper any slowdown that might be triggered by the fiscal squeeze.

“I’m very clear that monetary policy is the principle tool for stimulating demand,” Osborne said on Dec. 8.

‘Hawks’

While recent data indicate the recovery is faltering, inflation accelerated to 3.3 percent in November, the ninth month it exceeded the government’s 3 percent limit. Bank of England Deputy Governor Charles Bean said on Dec. 13 that price- expectations risks have increased and policy makers are watching “like proverbial hawks.”

Briton’s expectations of price increases for the coming year rose to 3.5 percent in December from 3.3 percent the previous month, Citigroup said on Jan. 4, citing a YouGov Plc survey. The central bank targets inflation of 2 percent.

The risk from rising inflation expectations prompted Societe Generale economist Brian Hilliard to change his rate forecast last week. He now sees officials increasing the rate by 0.5 percentage point in August and again in November. He previously forecast an unchanged rate until the second quarter of 2012.

‘Nightmare’ Scenario

Former policy maker David Blanchflower said on Jan. 7 it would be Osborne’s “worst nightmare” if the central bank began raising its key rate this year. The austerity measures for the fiscal year starting in April amount to about 40 billion pounds, or 2.5 percent of the economy. In all, about 330,000 public jobs will be eliminated by 2015 as part of the cuts.

“We have to keep interest rates really low because” an increase would “have a real kick-down for house prices and probably for consumption as well,” Blanchflower said. The bank’s Monetary Policy Committee “has to sit on its hands.”

Marks & Spencer Group Plc, the U.K.’s largest clothing retailer, said pressure on consumer finances from an increase in value-added tax will make business more difficult this year.

“We continue to expect the trading conditions ahead to be more challenging,” it said on Jan. 11. The retailer remains “cautious” about the outlook.

As the recovery shows signs of weakening, economists at Barclays Capital said policy makers need to balance their credibility on both inflation and growth.

They need to weigh up the “benefits of being seen to ‘do something’ in response to above-target inflation against the potential adverse macroeconomic consequences of a premature tightening,” said Simon Hayes at Barclays in London.

While manufacturing growth accelerated to a 16-year high last month, construction and services industries shrank. Consumer confidence stayed at a four-month low.

“The government wants the economy to grow as strongly as possible despite the fiscal squeeze,” said Vicky Redwood, an economist at Capital Economics Ltd. in London and a former Bank of England official. “I doubt they would see a rate rise as particularly helpful.”

To contact the reporter on this story: Scott Hamilton in London at shamilton8@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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