Inflation risk as economy to remain sluggish

The BoE’s Monetary Policy Committee decided to keep its main interest rate at a record-low of 0.5 per cent and its programme of bond purchases or quantitative easing (QE) at £375bn as expected, with stubborn inflation trumping worries about a sluggish economy.

The minutes to the December 5-6 meeting showed David Miles was again the only MPC member to support another expansion of the asset purchase programme, arguing that there was enough slack in the economy to allow higher output without extra inflation. He voted for a £25bn top-up.

“Most members agreed that developments on the month had done little to alter the balance of arguments between maintaining and increasing the size of the monetary stimulus,” the minutes said.

But there was little market reaction to the release.

Philip Shaw, economist at Investec, said it would probably take another two months of data to shift arguments over more quantitative easing one way or another. “It’s possible that the committee’s commentary over the economy from early next year becomes a little less downbeat,” he said.

“Our central view is that the MPC will refrain from sanctioning any further QE over 2012 but clearly that’s subject to economic developments.”

In November, the BoE agreed to return to the Treasury coupon payments on the gilts it had bought so far, saying the transfer would be equivalent to more than £35bn worth of monetary easing.

However, in the minutes the central bankers said the monetary impact of the transfer would be slightly smaller in the very short term than initially assumed, because it had led to a reduction in the issuance of Treasury bills rather than gilts.

“The committee agreed that an early understanding of the government’s gilt issuance plans for the 2013-14 financial year would be helpful for its monetary policy decisions,” they said.

Some lawmakers and economists have criticised the deal, saying it potentially threatened the BoE’s independence.

The minutes said economic output was likely to be broadly flat in the near term, but there would probably be a contraction in the fourth quarter.

Dangers from the eurozone had eased, although uncertainty about US budget talks posed risks.

“The deterioration in UK competitiveness over the past couple of years represented a potential headwind to the ability of UK exporters to benefit from a pick-up in global growth,” the minutes said.

The central bank also said inflation was likely to remain above its two per cent target for the next year or so, though food prices could be driven up by bad weather disrupting planting. Inflation held at 2.7 per cent in November, its highest since May, confounding forecasts for a dip.

Last week MPC member Paul Fisher said he would wait for signs inflation was coming down before voting to extend QE, though he added that more gilt purchases would probably be needed to keep policy accommodative. BoE chief economist Spencer Dale has warned that inflation was unlikely to fall back to target for some time, and the BoE’s own forecasts do not see inflation below two per cent until the third quarter of 2014.

Economists polled by Reuters do not expect any change in interest rates until then, and put the chance of more asset purchases at just 40 per cent.

High inflation, which peaked at 5.2 per cent last year, has weighed on consumer spending, holding back the economy’s recovery from its second recession in four years.

Investec’s Mr Shaw said inflation was likely to rise above three per cent over the next few months, cutting chances the Bank will add to QE.

A fall in petrol prices was not enough to outweigh increased costs for electricity, gas and food. In addition, services price inflation rose to 4.2 per cent, its highest since December 2011.

Last month, the central bank said inflation was likely to be much higher over the next 18 months than expected in August.

Inflation has been above two per cent since December 2009.