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King Seen Balancing Shift on Inflation With Eye on Pound

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

Bank of England Governor Mervyn King will tomorrow try to justify why officials stopped expanding stimulus even as the outlook for Europe’s economy darkens.

King will present economic forecasts at a press conference in London six days after the bank halted bond purchases. With the pound up 4 percent this year, he must be careful not to fuel a further increase in the currency that would pile pressure on an economy in a double-dip recession, said Alan Clarke, an economist at Scotiabank in London.

“I don’t think there’s any upside for them to provoke a further rally in the pound and a selloff in gilts,” Clarke said. Doing that would “undermine all the easing the bank has done over the last few months.”

The Bank of England’s decision to stop expanding so-called quantitative easing came after some officials stepped up their rhetoric on inflation, which remains above the central bank’s 2 percent target. Still, the intensification of Europe’s debt crisis amid political stalemate in Greece gives King reason to leave open the option for more stimulus if needed.

The pound has strengthened against all 16 major counterparts this year, including a 4.5 percent surge against the euro. On a trade-weighted basis, sterling is up about 4 percent in 2012. Further gains against the euro would threaten Britain’s competitiveness in a region that buys almost half of its exports. The pound rose to 79.63 pence per euro yesterday, the strongest in 3 1/2 years. It erased some of its gains today, declining 0.2 percent to 79.88 pence per euro at 8:13 a.m. in London.

‘Dovish Affair’

The Bank of England held its target for bond purchases at 325 billion pounds ($524 billion) on May 10, ending a second round of quantitative easing that started in October. King is due to publish the bank’s Inflation Report, including new growth and consumer-price forecasts, at 10:30 a.m. in London tomorrow.

“Relative to their stance of stopping stimulus, this will be a dovish affair,” said Jens Larsen, an economist at Royal Bank of Canada in London and a former Bank of England official. “The background is a disappointing growth outlook and the intensification of the European crisis; the other factor is the strengthening of sterling.”

Policy makers had flagged a shift in their thinking over the previous month, with minutes of the Monetary Policy Committee’s April meeting saying there was a risk that inflation may “fall less rapidly” than projected.

Above Estimate

Inflation accelerated to 3.5 percent in March from 3.4 percent in February. In the first quarter, it averaged 3.5 percent, above the 3.35 percent estimate by the Bank of England at its last quarterly forecasting round in February.

Scotiabank’s Clarke said while that means the near-term inflation outlook is higher, other factors may lower the projection at the end of the central bank’s two-year policy horizon. In February, the Bank of England forecast a 1.8 percent inflation rate in the first quarter of 2014. The pound’s appreciation and the weaker growth outlook cut that by as much as 0.3 percentage points, Clarke said.

“The markets are getting ahead of themselves in thinking that we’re witnessing a massive change in the bank’s stance,” he said. “It’s more of a realignment from a dovish bias to a more neutral one. Talk of a rate hike is a bit premature.”

Diamond Jubilee

Britain’s economy is still struggling to recover, with output about 4 percent below its peak in early 2008. It shrank 0.2 percent in the first quarter after a 0.3 percent contraction in the previous three months, and King has said it could shrink again in the current quarter due to an additional public holiday for Queen Elizabeth II’s Diamond Jubilee in June.

While policy makers have said the underlying pace of growth may be stronger than official data, they have expressed concern that the reports might undermine confidence. At the same time, mounting speculation that Greece will exit the euro area could further damp sentiment, impeding spending.

“While it’s understandable that the focus has shifted somewhat to inflation because it has been persistently higher than they have expected, the growth situation looks shakier,” said Simon Hayes, an economist at Barclays Plc in London and a former Bank of England official. “But it doesn’t make sense to become outright hawkish at this point because the situation is still very precarious.”

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