The Bank of England

There are certain things in life that we can be sure about…death..taxes and the fact that the Bank will leave rates unchanged on Thursday!! The Bank of England appears certain to keep interest rates at 0.50% at its July policy meeting as concerns mount regarding growth. Meanwhile, forthcoming data and survey releases are expected to indicate that the economy is struggling to generate decent growth and remains mired in a soft patch.

It now looks highly likely that an interest rate hike will be delayed until May 2012. Mounting growth concerns mean that if the Bank does act this year, it is increasingly possible that it will relax monetary policy by reviving QE) which has been ‘on hold’ since February 2010. However, given still-significant inflation risks, we believe that more QE is unlikely to occur unless the economy truly goes ‘belly-up’ over the coming months. Nevertheless, we now expect the Bank of England to refrain from raising interest rates until mid-2012. We suspect that most members of the MPC will maintain the view for many more months to come that higher interest rates are an extra handicap that the fragile economy can do without.

Furthermore, whenever interest rates do start to rise, the probability is that they will move up only gradually and remain very low compared with past norms. Monetary policy will need to stay loose for an extended period to offset the impact of the major, sustained fiscal squeeze. In addition, we believe that inflation will fall back markedly from late 2011/early 2012.Consequently, we suspect that interest rates will only rise to 1.50% by the end of 2012 (we have recently trimmed this from a previous forecast of 2.00% by end-2012).

The dynamics and mood within the Bank’s Monetary Policy Committee appear to have changed significantly, with a more dovish slant coming to the fore. The minutes of the June MPC meeting reveal that the vote in favour of keeping interest rates at 0.50% widened to 7–2 from 6–3 in each of the previous 4 months. This was because new member Ben Broadbent supported the "no change" interest rate opinion, which was in marked contrast to his predecessor Andrew Sentence, who had been the MPC's arch hawk and had actually been calling for interest rates to rise by 50 bps, from 0.50% to 1.00%. Martin Weale and Spencer Dale continued to vote for a 25 bps interest rate hike to 0.75% at the June meeting, but they are markedly less hawkish than Sentence was and both acknowledged that "the data on the growth outlook during the month had been weak."

Meanwhile, there was once again an 8–1 vote in favour of keeping the stock of QE unchanged at £200bn, where it has stood since February 2010, with Adam Posen wanting a £50bn increase to £250bn. Interestingly, though, for the first time in many months, the minutes revealed that some other MPC members acknowledged that further QE may be ‘warranted’ in the future if growth remained weak. With the minutes of the June meeting appearing appreciably more dovish because of heightened concerns about the economy, it appears increasingly likely that the Bank of England will hold off from raising interest rates until 2012. Furthermore, the possibility of renewed QE seems to be gaining traction.

With respect to economic activity, the minutes observed that "the current weakness of demand growth was likely to persist for longer than previously thought." There is particular concern within the MPC over the weakness of consumer spending, and they are also concerned by evidence of softening global growth. The MPC is also very aware that fiscal tightening increasingly kicked in from April. Events since the June MPC meeting are likely overall to have added to—rather than eased—growth concerns. For example, consumer confidence suffered a marked relapse in June, while the purchasing managers’ survey points to overall manufacturing activity being at a 21-month low in June with new orders contracting. The Office for National Statistics also revealed this week that output in the dominant services sector plunged 1.2% m/m in April, which is worrisome, even allowing for the ‘hit’ to activity caused by the extra public holiday resulting from the Royal Wedding.

While the MPC acknowledged that consumer price inflation (4.5% in April and May) is likely to reach 5.0% later this year because of utility price increases and stay above the 2.0% medium-term target level for an extended period, the committee drew comfort from the fact that inflation expectations seem relatively stable and wage growth remains muted. This supports the view that inflation will fall back markedly once the pressures from VAT changes, higher energy and commodity prices, and GBP's past devaluation.