King Confronts Stimulus Revival Case as U.K. Slump Persists

Bank of England Governor Mervyn King will today consider if Britain’s economy is vulnerable enough to warrant reigniting stimulus that officials halted a month ago.

While 37 of 42 economists forecast that the Monetary Policy Committee will keep its bond-purchase target on hold at 325 billion pounds ($503 billion), Morgan Stanley and Deutsche Bank AG are among banks that have switched their view in the past week to forecast more so-called quantitative easing in response to a weakening economy.

A gauge of services growth today exceeded economists’ forecasts, after data last week showed manufacturing shrank at the fastest pace in three years. While the central bank ended its second round of stimulus last month on risks to inflation, threats from Europe’s turmoil are growing as the debt crisis engulfs Spain.

“Services paints a more upbeat picture than last week’s manufacturing report and slightly reduces the pressure on the MPC to act at today’s meeting,” Vicky Redwood, an economist at Capital Economics in London and a former central bank official, said in a research note. “The big picture is that the recovery is still struggling. Even if the MPC holds fire today, we doubt that it will be long before more stimulus is forthcoming.”

The pound pared its decline against the dollar after the services report, and traded at $1.5475 as of 9:46 a.m. in London, down 0.1 percent on the day. Government bonds fell, with 10-year gilt yields rising 1 basis point to 1.676 percent.

Services Surprise

The services purchasing managers index, published by Markit Economics, held at 53.3 May, exceeding economists’ forecasts for a drop to 52.4. Policy makers had already seen the data. In the prior 74 months, there have been 38 upside surprises compared with the survey, 35 downside surprises and one case where the reading matched the forecast.

Markit’s manufacturing gauge on June 1 fell more than economists forecast to 45.9, the lowest since May 2009. A construction index released yesterday slipped to 54.4 from 55.8. Readings above 50 indicate growth.

Both Morgan Stanley and Deutsche Bank see a 50 billion- pound increase in stimulus today, while JPMorgan Chase & Co. brought forward its forecast for more QE to July from August after the manufacturing report. Morgan Stanley economists including Melanie Baker said in a note published yesterday that the chance of an interest-rate cut by the central bank have increased.

All 55 economists in a Bloomberg survey forecast that the Bank of England will today keep its benchmark rate at a record- low 0.5 percent, where it’s been since March 2009.

ECB Split

European Central Bank President Mario Draghi said yesterday that officials stand ready to act as the growth outlook worsens in the euro area, Britain’s biggest trading partner. While the ECB left its benchmark rate at 1 percent yesterday, Draghi said “a few” governing council members sought a rate cut.

“We monitor all developments closely and we stand ready to act,” he told reporters in Frankfurt.

The euro crisis is dominating central bank discussions around the globe. The Reserve Bank of Australia cut its key interest rate to the lowest since 2009 on June 5, citing “heightened political uncertainty and concerns about fiscal sustainability” in Europe. The Bank of Canada said the same day that “some of the risks around the European crisis are materializing” as it left its benchmark unchanged.

The Group of Seven nations agreed this week to coordinate their response to euro-area turmoil, which has tipped at least eight of the region’s economies into recession.

U.K. Inflation

The Bank of England declined to increase its QE target in May on signs that inflation wasn’t slowing as quickly as it had forecast earlier in the year. While consumer-price gains eased to 3 percent in April from 3.5 percent in March, that’s still above the central bank’s 2 percent target.

The slowdown in inflation “looks to be taking slightly longer than we had first thought,” policy maker Ben Broadbent said last month. “My answer to the questions as to why policy didn’t change in May: the forecast didn’t warrant it.”

The MPC raised its near-term inflation projection last month to reflect higher energy prices and indirect taxes. It still sees the rate falling below its target in the third quarter of 2013 because of “muted” domestic price pressure and labor-market slack that is limiting wage gains.

“It’s going to take a lot more time for inflation to hit the target,” said Philip Shaw, an economist at Investec Securities in London. “To get more QE, you need evidence either that inflation is moving decisively below 3 percent in the next few months or the real economic backdrop has become so poor that it’s justified despite the inflation level.”

Price Pressures

Signs that inflation pressures have eased may support the case for more bond purchases. The pound has risen about 2.2 percent on a trade-weighted basis since the start of the year, easing pressure from import prices, while oil prices have dropped 12 percent in the past month.

In addition to the threats to the U.K. from the euro area, Prime Minister David Cameron’s fiscal squeeze is also weighing on Britain’s economy. The International Monetary Fund said May 22 the U.K. may require further stimulus “via further QE and possibly cutting the policy rate.”

The weaker data create a “non-negligible risk” that the central bank will cut its key rate for the first time since March 2009, George Buckley, an economist at Deutsche Bank, said in a June 1 note.

“Conditions have worsened,” he wrote. “The MPC cannot ignore this weaker news.”

To contact the reporters on this story: Jennifer Ryan in London at jryan13@bloomberg.net; 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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