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Record Current-Account Gap Risks Yield Jump: Japan Credit

Bank of England Governor King
Mervyn King, governor of the Bank of England. Photographer: Chris Ratcliffe/Bloomberg

Bank of England Governor Mervyn King faces the prospect of a renewed rift among his officials as a dispute simmers on whether inflation threatens the U.K. economy.

The Monetary Policy Committee kept its bond-purchase target at 325 billion pounds ($514 billion) after raising it by 50 billion pounds last month, as forecast by all 45 economists in a Bloomberg News survey. Over the past two weeks, potential divisions emerged after Martin Weale indicated he may not favor further purchases after the current round ends in May and David Miles said there’s a case for “aggressively” loosening policy.

The Monetary Policy Committee’s debate coincides with a clouded outlook for the U.K. as an increase in crude-oil prices threatens to stoke inflation, while the economy is still struggling after a fourth-quarter contraction. Surveys indicate the economy will avoid another recession, though King has said the recovery will only be gradual.

“Today’s vote was probably unanimous, though there are signs of a three-way split emerging,” said Ross Walker, an economist at Royal Bank of Scotland Group Plc in London. “Our call in May is for no change to quantitative easing. The signs of recovery weigh in favor of a pause.”

The MPC also held its benchmark interest rate at a record low 0.5 percent. This month marks the third anniversary of the central bank’s QE program, started in the wake of the collapse of Lehman Brothers Holdings Inc. and a government rescue of some of the nation’s biggest banks.

Global Pause

The European Central Bank left its benchmark rate at 1 percent today after a meeting of its Governing Council, as predicted by 56 of 58 economists in another survey.

Global central banks are pausing to take stock of the economic outlook after a round of monetary easing which Bank of America Merrill Lynch calculates to have included about 30 interest rate cuts in the past four months and $1 trillion of asset-buying in the last seven.

The U.S. Federal Reserve has committed to low rates through 2014 and the Bank of Canada will probably keep its main rate at 1 percent at 9 a.m. in Ottawa. Indonesia’s central bank held its reference rate at 5.75 percent today and the Reserve Bank of New Zealand signaled it may leave its official cash rate at a record low of 2.5 percent for much of 2012.

Bond Impact

The U.K. central bank’s stimulus, along with Chancellor of the Exchequer George Osborne’s commitment to his deficit-cutting program, is helping to support bonds. The yield on the 10-year gilt was at 2.16 percent today, compared with almost 4 percent a year ago. The pound was little changed against the dollar after today’s MPC decision, up 0.4 percent on the day at $1.5801 as of 12:17 p.m.

Osborne will announce his budget for the fiscal year beginning in April on March 21. PricewaterhouseCoopers LLP said today the deficit for the current year may undershoot borrowing forecasts by about 7 billion pounds, giving him scope to provide a “temporary” boost to the economy.

The MPC was unanimous in the decision to raise the bond-purchase target in February, though it was divided on the size of the increase, with Miles and Adam Posen favoring 75 billion pounds. There was a “range of views” on inflation risks, according to the minutes of the meeting, with some officials saying a case could be made for not adding to stimulus.

Inflation Debate

While inflation eased to a 14-month low of 3.6 percent in January, that’s still above the bank’s 2 percent target. Crude-oil prices have risen about 20 percent in the past six months. The central bank sees inflation slowing to 1.9 percent by the end of this year and 1.8 percent by end-2013.

Weale said in a Feb. 29 speech there is a “risk that there may be more persistence to inflation than one might expect at a time of rising unemployment and weak demand.” Deputy Governor Charles Bean said the same day that while he expects inflation to cool in the near term, his longer-term outlook is “slightly north” of the MPC’s central forecast.

Miles has spelled out the opposing argument, saying that “aggressively loosening monetary policy” could be better for the economy. King said on Feb. 29 that future decisions will depend on economic data and policy makers “will take whatever action we think appropriate.”

Euro Crisis

Surveys this month indicate that the U.K. economy returned to growth in the first quarter after a 0.2 percent contraction in the last three months of 2011. Reports from Markit Economics showed manufacturing and services continued to expand in February, while GfK NOP’s consumer confidence index held at the highest since June.

Still, the euro-area debt crisis remains a threat, with Bean saying on Feb. 21 that the agreement on a second bailout for Greece may not be enough to end the turmoil. The euro crisis “represents the biggest downside risk” to the U.K., he said.

With the ongoing threats to the recovery, the “splintering” within the MPC may not be enough to prevent more quantitative easing, said Philip Rush, an economist at Nomura International Plc in London.

“I don’t think they’re going to be particularly fearful about inflation for quite a long time,” he said. “The sense of splintering of the committee’s view is going to be more around the edges and subtleties of just how much QE they should be doing and how many years they should hold off before eventually hiking rates.”

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