BOE Keeps QE on Hold as Inflation Risks Override Recession

June 7 (Bloomberg) -- Bloomberg's Sara Eisen reports that the Bank of England left its stimulus plan on hold as the threat from above-target inflation overrode policy makers’ concerns about the risk to the U.K. from Europe’s debt crisis. She speaks on Bloomberg Television's "Inside Track." (Source: Bloomberg)

The Bank of England left its stimulus plan on hold as the threat from above-target inflation overrode policy makers’ concerns about the risk to the U.K. from Europe’s debt crisis.

The Monetary Policy Committee, led by Governor Mervyn King, held its ceiling for bond purchases at 325 billion pounds ($503 billion) today, a move forecast by 37 out of 42 economists in a Bloomberg News survey. Officials also kept their benchmark interest rate at a record low of 0.5 percent.

Services unexpectedly maintained their pace of expansion in May, a report today showed, signaling some strength in the economy after a manufacturing index slumped last week. Still, the turmoil in the euro area remains a threat to global growth and China’s central bank cut interest rates for the first time since 2008 today.

“There’s a good chance they’ll have to come back and do more quantitative easing,” said David Tinsley, an economist at BNP Paribas SA in London and a former Bank of England official. “The euro zone tends to keep coming back to bite everybody so there’s a reasonable chance it will do so again.”

The People’s Bank of China said its benchmark one-year deposit rate will drop by 0.25 percentage points effective tomorrow, while the one-year lending rate will also decline by 0.25 percentage points.

Stocks Gain

Stocks jumped after the PBOC announcement, which fanned optimism that policy makers around the world will do more to bolster growth. The Stoxx Europe 600 (SXXP) rose 1.4 percent as of 12:53 p.m. in London and the MSCI Asia Pacific Index added 1.5 percent. The pound erased its loss against the dollar and traded at $1.5575, up 0.5 percent from yesterday.

The U.K. services purchasing managers index, published by Markit Economics, unexpectedly held at 53.3 in May, while economists forecast a drop to 52.4. The report also showed that input-price inflation eased. Markit’s factory gauge on June 1 fell to 45.9, the lowest since May 2009.

Today’s Bank of England decision signals price-growth worries are still paramount even as the U.K. struggles with government budget cuts, high unemployment and threats from Europe’s turmoil. 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.

BOE Minutes

“We suspect further policy stimulus will be forthcoming,” said James Knightley, an economist at ING Group in London, citing a “weak” consumer backdrop, government budget cuts and companies’ reluctance to invest. “That said, what the U.K. economy really needs is action on the euro-zone sovereign debt crisis.”

Britain’s economy shrank 0.3 percent in the first quarter after contracting by the same amount in the last three months of 2011. The International Monetary Fund said on May 22 that the U.K. may require further stimulus “via further QE and possibly cutting the policy rate.”

Minutes of the Bank of England’s meeting will be published June 20 and may reveal a split on the MPC. While David Miles was the only member to vote for more QE last month, officials including Charles Bean have said the central bank can resume bond purchases if needed. Meanwhile, Spencer Dale said last week the MPC needs to get inflation back to target and its current policy stance looks “broadly right.”

The European Central Bank is also split on its response to the euro turmoil. While it kept its key rate on hold yesterday, President Mario Draghi said “a few” Governing Council members pushed for a reduction.

Euro Risks

In the euro area, which King has said is the biggest threat to the U.K., Spain is struggling to contain speculation it will need a bailout, while a second election in Greece on June 17 has fueled concerns the country may exit the euro.

ECB President Draghi said yesterday that officials stand ready to act as the growth outlook worsens in the euro area, Britain’s biggest trading partner.

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.

To contact the reporters on this story: Scott Hamilton in London at shamilton8@bloomberg.net; Jennifer Ryan in London at jryan13@bloomberg.net

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

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