UK: Downbeat Bank Likely to Consider More QE

The Bank of England is not given to making commitments to keeping interest rates steady for two years and will not do so now, according to Mervyn King, the Governor. But the markets appear to be doing that job anyway. According to King, the market view on rates implies something pretty close to unchanged rates for the next two years.

As expected, the Bank downgraded its growth forecasts and thinks there is an even chance of inflation being above or below the 2% target in two years’ time. That is on the basis of the market profile for rates and the existing £200 billion of asset purchases, or quantitative easing. More QE could come into the frame if the monetary policy committee thinks inflation is heading decisively below target. Some would argue that the bar should be set rather higher than that but more QE will be the thing to watch out for over the coming months.

This is King on the headwinds to growth: “Over the past year, output, according to initial official estimates, has grown by less than 1%, reflecting a substantial squeeze on households’ real incomes. Underlying growth in the second quarter was probably stronger than the headline figure of 0.2% once we allow for the effect of special factors, such as the additional bank holiday, although the reverse is likely to be true of the third quarter. In the Committee’s view, the weakness in underlying activity is likely to be somewhat more persistent than previously expected.

“There are a number of headwinds to world and domestic growth over the forecast period, not least the private and public debt overhang. And these headwinds are becoming stronger by the day. Reflecting this, and the prolonged period of economic adjustment facing some countries, the MPC’s projections embody relatively slow growth in the euro area. The intensification of sovereign fiscal concerns has been associated with renewed funding stresses for banks which are contributing to high borrowing spreads, tight credit conditions for households and smaller companies, and exceptionally weak credit and money growth in the UK.”

And on the risks facing the UK and other advanced economies: “It is almost exactly four years since the start of the financial crisis. The origins of the crisis lie in the large stocks of indebtedness that resulted from the widening imbalances in the world economy, about which nothing was done for so long. One way or another, the losses that were built up in recent years will have to be shared between creditors and debtors; in the world economy between creditors in the East and debtors in the West, and within the euro area between creditors in the North and debtors in the South.

“The key question is whether that burden sharing will take place in the context of a downturn in the world economy, or whether it will take place in the context of a rebalancing of overall demand. The big risks facing the UK economy come from the rest of the world. We must work with our colleagues abroad to tackle the challenge of how to reduce the overhang of private and public debt. But there is a limit to what UK monetary policy can do when large real adjustments are required. And it cannot influence inflation over the next few months. But it can ensure that policy is set in such a way that these adjustments take place against a backdrop of low and stable inflation. And that is exactly what the MPC will do.”

So a difficult environment. The inflation report is here.

This post originally appeared at David Smith’s EconomicsUK and is reproduced with permission.