Bank of England minutes showed some policy makers see a potential need for further bond purchases as the economic recovery struggles and “downside” risks to growth and inflation mount.
For the majority of the nine-member Monetary Policy Committee, “the fiscal challenges in the euro-area periphery highlighted the potential for further adverse shocks to demand,” according to minutes of the June 8-9 meeting published today in London. “For some of these members, it was possible that further asset purchases might become warranted if the downside risks to medium-term inflation materialized.”
The pound dropped after the minutes. While U.K. inflation was 4.5 percent in May, more than twice the central bank’s target, Governor Mervyn King said last week that the current price surge is temporary as he defended keeping the key rate on hold to aid the economic recovery during the government’s budget cuts. Paul Fisher said yesterday that adding to the bank’s bond program remains “very much on the table” as a policy tool.
The MPC voted 7-2 to keep the benchmark interest rate on hold and 8-1 to maintain the bond-purchase program at 200 billion pounds ($323 billion), with the majority saying the “current weakness of demand growth was likely to persist for longer than previously though.”
The pound extended its decline against the dollar and was at $1.6145 as of 10:17 a.m. in London, down 0.6 percent from yesterday. Government bonds furthered their advance, pushing the yield on the 10-year gilt 6 basis points lower to 3.17 percent. Two-year note yields dropped 5 basis points to 0.75 percent.
Economists at Unicredit today pushed back their forecast for when the central bank will begin raising interest rates to February 2012 from August. It cited the “weaker-than-expected performance of the economy” and “concerns expressed by most MPC members about the weakness of the economic outlook.”
“The very fact that it’s featured in the minutes represents a shift,” said Richard Barwell, an economist at Royal Bank of Scotland Group Plc in London and a former central bank official, referring to the bond purchases. “There’s been no growth in the past six months, no domestically generated inflation and fiscal policy is tightening.”
Martin Weale and Chief Economist Spencer Dale continued a push for a quarter-point increase in the benchmark rate. King and the other six members of the MPC, including Ben Broadbent, voted for no change. Broadbent replaced Andrew Sentance, who had been calling for a half-point rate increase. Adam Posen kept up his call for more bond purchases, which he began in October.
“For one member, the balance of risks to inflation continued to warrant an immediate expansion of the committee’s program of asset purchases,” the minutes said. “For that member, it was likely that inflation would fall below the target in the medium term.”
Investors have pushed back bets on the first increase to beyond May 2012, according to forward contracts on the sterling overnight interbank average. On June 1, traders were betting on an increase in February, data from Tullett Prebon Plc showed.
“There do seem to be even further risks to the downside, so it’s perfectly reasonable for the bank to keep its options open,” said Hetal Mehta, an economist at Daiwa Capital Markets Europe Ltd. in London. “There’s no real evidence that inflation expectations are feeding through.”
The MPC said today that measures of household and financial-market inflation expectations “had not moved materially,” and recent wage data “had remained subdued.”
With the bank forecasting that inflation might accelerate to above 5 percent in the coming months, that “raised the likelihood that such inflation might come to be regarded as the norm,” it said. Nevertheless, the “relative stability of inflation expectations could, however, suggest that they were more firmly rooted than might have been expected.”
For Dale and Weale, the argument to increase interest rates remained “strong,” though they noted that the “data on the growth outlook during the month had been weak.”
The IMF lowered its 2011 U.K. growth forecast this month to 1.5 percent from 1.7 percent in April. It sees growth accelerating to 2.5 percent in the medium term. The central bank said today that “while activity in the euro area as a whole had remained resilient, sovereign-debt and banking problems could intensify, perhaps significantly, to the detriment of economic activity and the financial system.”
Greek Prime Minister George Papandreou won a confidence vote in the parliament early this morning as he tries to push through budget cuts to stave off default. The IMF said yesterday that Spain must step up efforts to overhaul its economy as Europe’s sovereign-debt crisis threatens to damp growth.
“The medium-term outlook for demand remained extremely difficult to judge,” the minutes said. “More positively, U.K. net trade had surprised to the upside and there were signs that the necessary rebalancing of the economy was under way.”
On the longer-term outlook, the policy committee said the “array of erratic factors affecting measured output made any assessment of the current underlying state of the domestic and global economy highly uncertain.”