King Diverges Further From Europe as BOE Keeps Rates on Hold

Bank of England Governor Mervyn King
Bank of England Governor Mervyn King. Photographer: Simon Dawson/Bloomberg

Bank of England Governor Mervyn King’s monetary policy diverged further from the rest of Europe today as officials kept record-low interest rates to aid the recovery and guard against threats from the Greek crisis.

The nine-member Monetary Policy Committee held the benchmark rate at 0.5 percent in London today, as forecast by all 51 economists in a Bloomberg News survey. The Frankfurt-based European Central Bank raised its key rate by a quarter point for the second time this year.

With companies such as Bombardier Inc. cutting jobs and retailers Thorntons Plc and Carpetright Plc shutting stores, King is persisting in his tolerance of soaring inflation to aid the economic recovery. He defended his stance on June 28, saying the bank can hold off raising rates if there is a risk of “undesirable volatility in output” and also warned of threats to the U.K. from the debt crisis in the euro area.

“We’re facing a prolonged period of very loose monetary policy,” Jonathan Loynes, chief European economist at Capital Economics Ltd. in London, said in a telephone interview. “There are still conflicting pressures, but our sense is that the inflation pressures will prove temporary and that worries about activity will ultimately prevail. We don’t think rates will rise before 2013.”

Pound Decline

The pound was little changed against the dollar after the announcement and traded at $1.5969 as of 1:18 p.m., down 0.2 percent on the day. It has dropped against all 16 currencies tracked by Bloomberg in the past three months. Bonds declined, with the yield on the 10-year gilt rising 2 basis points to 3.26 percent.

The Bank of England also held its bond-purchase program at 200 billion pounds ($320 billion), a move predicted by all 32 economists in a Bloomberg survey.

The ECB’s rate increase lifted its benchmark to 1.5 percent, the highest since March 2009. Sweden raised its benchmark repurchase rate to 2 percent on July 5, the seventh increase in a year. Beyond Europe, the People’s Bank of China raised key rates for the third time this year yesterday.

While U.K. inflation has accelerated to 4.5 percent, more than twice the central bank’s target, investors have pushed back expectations for the next Bank of England rate increase to beyond May 2012, according to forward contracts on the sterling overnight interbank average. A month ago, they were betting on a February increase.

Economic Outlook

While the economy grew 0.5 percent in the first quarter, it shrank by that amount in the previous three months. Markit Economics said its surveys of manufacturing and services point to gross-domestic-product growth of 0.3 percent “at best” in the second quarter.

Data today showed factory production rose 1.8 percent in May, the fastest pace in more than a year, marking a rebound from the impact of an extra public holiday in April and the Japanese earthquake.

Policy makers said in the minutes of their June meeting that the current weakness of demand growth is “likely to persist for longer than previously thought,” with some raising the possibility that further bond purchases may be needed.

In addition, Europe’s debt crisis “highlighted the potential for further adverse shocks,” the minutes said.

Retail sales fell 1.4 percent in May as consumers grappled with faster inflation, the biggest fiscal tightening since World War II and signs the labor market is coming under pressure. Bombardier, the world’s biggest trainmaker, said this week it will eliminate more than 1,400 jobs at a plant in Derby, England, after it lost a government contract.

Inflation Expectations

“There’s no evidence that the consumer is getting any better,” said David Tinsley, an economist at National Australia Bank in London and a former central bank official. “The bank isn’t coming under any pressure for an increase.”

The MPC split three ways on policy last month after the rate of price growth convinced Chief Economist Spencer Dale and policy maker Martin Weale to continue a push for a rate increase. Adam Posen called for more bond purchases. Minutes of today’s decision will be published July 20.

Prices have been fuelled by the pound’s drop of about 25 percent on a trade-weighted basis since the start of 2007, a sales-tax increase and rising commodity costs. Britons’ inflation expectations for the coming year jumped to 3.9 percent in June, the highest since 2008, according to a YouGov Plc poll, raising the risk faster price gains get entrenched.

Deputy Governor Paul Tucker said June 28 that he is “one of those who from the back end of last year has worried about the possibility of an upward drift in inflation expectations.” He also said he has a “high threshold” on the need for more stimulus.

While growth in take-home pay accelerated to 3.3 percent in the second quarter, Vocalink Ltd. said today, it remains below the rate of inflation.

“The Bank of England appears to be winning the propaganda battle on inflation,” Commerzbank’s Dixon said. “The question remains whether it’s going to win the war.”

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