Bank looks set to drop QE in recovery gamble

Minutes of the Bank’s April meeting, combined with a stark warning on inflation from Deputy Governor Paul Tucker on the same day, signalled a sharp change in tone that could bring forward expectations for interest rate rises.

The pound shot up to a 19-month high against the euro.

Evidence that the UK economy may be on the mend – something that would make further stimulus unnecessary – came from Government data showing an unexpected fall in unemployment in the three months to February.

The economy has not yet recovered from the 2007-2009 crisis, but the central bank said that while official figures could well show that the country had slipped back into recession, business surveys pointed to underlying growth.

Mr Tucker, meanwhile, said that recent inflation news had been “bad”, including data on Tuesday showing higher fuel, food and clothing costs had pushed inflation higher for the first time in six months.

It was a message echoed in the minutes, in which the long-standing flag-bearer for further bank asset-buying, or quantitative easing, Adam Posen, dropped his call for more QE, leaving only one policymaker supporting more potentially inflationary stimulus.

“Monetary policy will underpin the recovery so long as that remains consistent with anchoring inflation expectations in line with achieving the 2 per cent target over the medium run,” Mr Tucker said in a speech. “We shall not let that slip.”

Most economists do not expect a rate rise before 2014, but Wednesday’s joint events could shift this.

Inflation hit a three-year high of 5.2 per cent in September, and at its February meeting the Bank had forecast it would drop below its 2 per cent target by the end of the year.

However, inflation data on Tuesday showed that it nudged higher to 3.5 per cent in March, the first increase in six months, due to higher fuel, food and clothing costs.

In Wednesday’s minutes the Bank said inflation was likely to be higher than forecast in the short term – and more critically, there was a greater risk that above-target inflation could persist into the medium term.

“All the signs now are that the MPC will pause on asset purchases from May,” said David Tinsley, UK economist at BNP Paribas.

“They may come back to QE later this year should the economy flag, but for now it looks like the output/inflation outlook has shifted.”

The Government may be uneasy about the Bank’s apparent intention not to raise its £325bn target for quantitative easing next month, when the £50bn of gilt purchases approved in February are complete.

Monetary policy has been an important plank supporting Britain’s economy at a time when hefty public spending cuts are underway, and the Bank itself said that official growth data next week may well show the economy is in a technical recession.

But the Bank said it placed more weight on survey evidence that a moderate recovery was on track than on data from the Office for National Statistics that it said would probably be distorted by a “perplexing” slump in construction output.

“The sharp falls in construction output in December and January were perplexing, and the committee was minded not to place much weight on them,” the minutes said. “A wide range of survey indicators pointed to a moderate rate of growth in activity in the first half of the year.”

The official unemployment data released yesterday offered some support to the Bank’s view.

The headline rate fell to 8.3 per cent from 8.4 per cent, its lowest since the three months to October 2011.

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