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BOE Mulls ‘Second Wave’ of Stimulus as Rebound Fades

BOE Governor Mervyn King
Mervyn King, governor of the Bank of England. Photographer: Simon Dawson/Bloomberg

Bank of England Governor Mervyn King may have to embark on a new round of bond purchases as Britain’s rebound from the worst recession since World War II fades.

Manufacturing, services and construction all faltered in August and the housing market weakened, surveys showed last week. That suggests 200 billion pounds ($309 billion) in bond purchases by the central bank since March 2009 and record-low interest rates may not be enough to keep up the economy’s momentum in the deepest budget squeeze in more than six decades.

“They are more likely to loosen policy further before they tighten it,” Alan Clarke, an economist at BNP Paribas in London, said in a telephone interview. “The danger is acting too late and not soon enough.”

Bank of England policy makers have discussed expanding the bond-purchase policy over the past two months. While officials say it has aided growth by shaving 1 percentage point off government bond yields, it has so far failed to ramp up the flow of credit in the economy.

Clarke predicts the bank’s nine-member Monetary Policy Committee will agree to a “second wave” of stimulus in February. Ross Walker at Royal Bank of Scotland Group Plc says the chances of it happening in early 2011 are as high as 40 percent. None of the 31 economists surveyed by Bloomberg News forecast an expansion of stimulus after the bank’s policy decision at noon today in London.

‘Uneven’ Recovery

The central bank will keep the benchmark interest rate at 0.5 percent for a 19th month today, according to all 56 economists in a separate Bloomberg News survey.

The pound fell today as Deputy Prime Minister Nick Clegg said the U.K.’s recovery will probably be “choppy and uneven.” The currency dropped 0.6 percent against the dollar to $1.5399 as of 10:58 a.m. in London.

Britain’s economy “remains fragile” and “further policy action may yet be necessary to keep the recovery on track,” Bank of England Deputy Governor Charles Bean said on Aug. 28. His comments are the most recent remarks by a U.K. policy maker.

While gross domestic product grew 1.2 percent in the second quarter, the most in nine years, the Chartered Institute of Purchasing and Supply said last week that its U.K. factory, services and construction indexes all slowed more than expected in August. House prices fell 0.9 percent in August, the most in six months, Nationwide Building Society said on Sept. 2.

Hays, RBS

Hays Plc, the U.K.’s biggest recruitment firm, said last week that full-year profit dropped 91 percent as permanent hiring slumped. RBS, Britain’s biggest government-controlled bank, will eliminate 3,500 U.K. jobs and close 10 offices to reduce costs, the lender said on Sept. 2.

“The most recent survey evidence is now suggesting that the recovery has pretty much ground to a halt,” Jonathan Loynes, chief European economist at Capital Economics Ltd. in London, said in a telephone interview. “The bank has been slowly moving towards the idea of more policy loosening over the past few months and unless the tone of the data starts to turn around quite soon, they’ll continue to move in that direction.”

Bank of England policy makers are currently split on the direction of policy as they argue on whether inflation or spending cuts pose a bigger risk to the economy. Andrew Sentance has pressed for an interest-rate increase since June to curb inflation, which was 3.1 percent in July, above the government’s 3 percent limit for a fifth month. The rest voted for no change.

Buckley’s View

Some economists including George Buckley at Deutsche Bank AG predict the central bank’s next move will be an interest-rate increase rather than an expansion of stimulus.

“There is a possibility of them doing more quantitative easing, but I don’t think they will,” Buckley said in a telephone interview. “My central forecast is that they’ll raise interest rates in 2011.”

Buckley says there’s still a risk of a double-dip recession in the U.K., which faces the prospect of the toughest budget cuts since World War II. Chancellor of the Exchequer George Osborne will detail 61 billion pounds of spending reductions on Oct. 20. The scale of the measures prompted King to trim his quarterly growth estimates on Aug. 11 and say inflation will probably slow below the bank’s 2 percent target in 2012.

Deterioration in the U.S. economy may also sway the Bank of England and other central banks towards expanding stimulus. The Bank of Japan already said on Sept. 7 it’s prepared to add more monetary stimulus due to “uncertainty about the future, especially for the U.S.”

Fed Decision

Federal Reserve policy makers said on Aug. 10 they’re prepared to maintain their holdings of securities to prevent money from being drained out of the financial system in their first attempt to bolster the economy in more than a year. The European Central Bank last week said it will keep offering banks unlimited liquidity until at least January.

The Bank of England “might have to wait for the Fed to move before launching more quantitative easing,” RBS’s Walker said. “With the balance of risks tilting towards the recovery faltering, they are getting some slack, but only really if the Fed embarks on this can they follow.”

BNP economist Clarke says Bank of England officials could probably justify further bond purchases using their new forecasts, though the current strength of price pressures makes it less palatable for them as they seek to preserve their inflation-fighting credentials.

“Clearly they are concerned that loosening in an environment where the latest GDP figure is 1.2 percent and the latest inflation figure is above 3 percent would undermine their credibility,” he said. “That’s the trap they’re in.”

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