BoE: No Change In Policy, But Discussions On Inflation Mandate

We expect the Bank of England (BoE) to remain on hold at Thursday’s Monetary Policy Committee (MPC) meeting. Any policy changes on Thursday would be a surprise. All analysts surveyed by Bloomberg expect both unchanged rates and that the Asset Purchase Facility (APF) will be kept on hold at GBP375bn.

At the November meeting, the effects of a rate cut were discussed with the conclusion that a cut might prove counterproductive for aggregate demand as a whole. Staff analysis points to a likely reduction in the profitability for lenders, where in particular building societies have loans with interest terms linked to the Bank Rate. Hence, we expect the Bank Rate to be floored at the current 0.50% and a possible rate hike seems a long way off given the weakness of the UK recovery.

The general tone in the December minutes indicates that the MPC is in a wait-and-see mode. The BoE forecasts a slow recovery of the UK economy and it is still too early to judge the effects from the Funding for Lending Scheme (FLS). Inflation is expected to remain above 2% for most of 2013 and the members stated that "developments on the month had done little to alter the balance of arguments between maintaining and increasing the size of the monetary stimulus."

In a speech in mid-December, MPC member Spencer Dale outlined his stance against more quantitative easing (QE), stating he would not have voted for more QE even in the absence of the Treasury’s decision to transfer APF coupons (equivalent to a monetary expansion in the short run), as e.g. Bent Broadbent stated he would. As a lone minority voter, David Miles has been voting in favour of increasing the size by a further GBP25bn for two months. As this is not an unusual position for Mr Miles (he was a minority voter six times in 2012), we do not expect many more MPC members to support this for now.

While data on actual lending to households remained broadly flat in November and the first statistics on FLS point to a slow start, BoE’s 2012 Q4 Credit Condition Survey points to an improvement in UK lenders’ willingness to supply of credit. It will be some months before the effectiveness of FLS can be assessed. Nevertheless, it seems that the MPC has faith that the FLS will ease credit conditions and feed through to the real economy.

The Bank of Canada’s governor, Mark Carney, will take over from Sir Mervyn King in July 2013. This will be interesting given Carney’s recent statement that central banks should consider more radical measures such as clearer policy guidance (see Research UK: NGDP level targeting in the UK don’t ignore it, 12 December 2012). Carney’s speech on new policy measures and guidance has started a wide discussion on BoE’s inflation mandate. However, changes are remote as the Chancellor of the Exchequer, George Osborne, stated "inflation targeting had served the country well" and "benefits would have to be substantial to warrant a shift." Nonetheless, the discussion should be followed closely as a shift to, for instance, nominal GDP targeting could have substantial market implications.

If we are right and BoE remains on hold, we expect a muted market reaction.

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