Bank inflation report could put QE back on the agenda

After a weekend of frantic discussions among global financial policymakers, investors are trying to gauge if the latest ructions have made a new bout of quantitative easing by the Bank more likely.

Whatever the new growth and inflation forecasts in the report, they risk looking out of date as soon as Bank of England Governor Mervyn King presents them, as the cut-off for new data was last Wednesday – pre-dating sharp share price falls since Thursday and Friday’s downgrade to the United States’ sovereign rating.

Instead of the usual concern about how long it will take inflation – currently 4.2 per cent – to return to the Bank’s 2 per cent target, attention is set to focus on whether Britain faces a repeat of the 2008 financial crash.

“I think it’s about getting a sense of how serious King thinks this contagion will be,” said Ross Walker, an economist at Royal Bank of Scotland. “We know the Bank were quick out of the blocks during the last financial crisis.” The Bank has kept interest rates on hold at 0.5 per cent since March 2009, and even before the latest events it was faced with an economic recovery that has stalled for the past nine months.

For now, few economists believe that the Bank is about to embark on a new round of quantitative easing to top up the £200bn of gilt purchases conducted between March 2009 and February 2010.

Only one Bank official, Adam Posen, supported more QE last month, though others on the nine-member Monetary Policy Committee (MPC) mulled it as a crisis option.

But with a rapidly-evolving market situation – as investors reassess the risk of holding US and European government bonds, the bedrock of the financial system – Mr Walker said he would be looking for some indication of whether the Bank was preparing for more QE if things turn worse.

Mr King has been a major supporter of the government’s budget deficit reduction programme, meaning in theory he should favour monetary rather than fiscal stimulus if the economy lurches towards recession.

However, with 10-year gilt yields already at a record low, more purchases of these assets might not prove much of a help, Mr Walker said, adding he would be looking for any hint the Bank might take other measures to support the economy.

The BoE’s options are restricted, though. British corporate bond and commercial paper markets are smaller than in other advanced economies, which has limited past central bank intervention there, and the Bank has strongly resisted calls to extend its 2008 Special Liquidity Scheme for banks.

In terms of the inflation report, the Bank’s growth forecasts for this year, and to a lesser extent 2012, are set for a downward revision, a Reuters poll showed.