BOE Says Upside Risk to Inflation Has Eased as Stimulus Mulled

The Bank of England said upside risks to consumers’ inflation expectations eased in recent months, as it edges closer to restarting stimulus to strengthen the economy against the threats from the euro-area debt crisis.

“The upside risk from inflation expectations may have receded a little relative to autumn 2011” and the risk from longer-term expectations “appears to have not crystallized,” Rashmi Harimohan of the Monetary Assessment Division said in an article in the central bank’s Quarterly Bulletin published today. “There are also few signs that past inflation expectations have fed into wages.”

Data yesterday showed inflation slowed to 2.8 percent in May, the weakest since December 2009, which may ease resistance among policy makers to add to bond purchases. The central bank will begin auctions in a new liquidity operation later today, while it will also publish the minutes of its June 6-7 policy meeting, showing how officials voted when they kept their bond-purchase target at 325 billion pounds ($510 billion).

“The outlook for inflation is uncertain, but the Monetary Policy Committee judges that inflation is likely to remain above target throughout 2012, before falling back during 2013,” Harimohan said. Still, “some risk remains” to expectations as long as inflation is above the central bank’s 2 percent target.

Since the June meeting, policy maker Adam Posen said that more asset purchases could aid the economy, and that he was “too optimistic” when he abandoned a push for more stimulus in April. Bank of England Governor Mervyn King said on June 14 that the case for loosening policy is “growing” as the euro-area debt crisis casts “a long shadow over our own recovery.”

Emergency Liquidity

The central bank said yesterday its first auction in its new Extended Collateral Term Repo Facility will be 5 billion pounds of six-month funds. Bids may be submitted from 10:30 a.m.

King said last week policy makers will activate the facility, first announced in December, to boost liquidity available to banks amid “dark clouds” from Europe. The ECTR operation will provide sterling against the widest range of collateral and is open to all banks and building societies that are signed up to its Discount Window Facility.

In a separate article in today’s bulletin, the central bank said investor confidence fell in the second quarter because of increased concerns about the euro area, where Spain this month sought aid for its banks, becoming the fourth member nation to seek a bailout.

“Financial-market sentiment deteriorated markedly over the review period amid renewed concerns about the vulnerabilities associated with the indebtedness and competitiveness of several euro-area economies,” the Bank of England said.

Rate Forecasts

The central bank also said that market participants pushed back forecasts for the timing of an increase in the benchmark interest rate and “placed some weight” on the possibility of a cut in the rate below the current record low of 0.5 percent.

“Contacts attributed the moves largely to a combination of weaker U.K. economic data and the implications for the U.K. economy of growing concerns about the outlook in the euro area,” it said.

In an article on U.K. productivity, the Bank of England said it is “likely that, alongside substantial spare capacity within the labor market, a margin of spare capacity remains within companies.”

The central bank said in another report that its so-called quantitative-easing program, through which its buys U.K. government bonds, “appears to be less well understood than the setting of interest rates.” While 26 percent of respondents to a survey thought the main aim of QE was to increase confidence, just 9 percent thought it was to stop inflation falling below target, while 36 percent said they didn’t know what the program’s primary objective was.

“The MPC has agreed that explaining QE should continue to be an important area for the bank’s communication strategy,” the central bank said.

It also said that satisfaction with the way it sets interest rates has fallen since the onset of the financial crisis, “but remains positive.” That may partly reflect “ongoing concerns about the economic outlook,” it said.

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