Analysis: Tsy Ctee Hearing Suggests Split BOE MPC To Sit Tight

LONDON (MNI) – Bank of England Monetary Policy Committee members
are united in the belief that judging the correct setting for monetary
policy at present is fraught with difficulty.

Clear downside risks threaten the international economic recovery
while elevated inflation expectations at home are troubling and there is
no unanimity on what to do next.

The testimony of MPC members at the Treasury Select Committee
showed ready agreement on the complexities of setting policy, and an
acknowledgement of the deep uncertainties surrounding the inflation
outlook. The splits come over how they view the balance of risks, with
MPC member Andrew Sentance at one end of the spectrum calling for
immediate policy tightening and – at the other – David Miles saying
further stimulus could be required.

The only (near) certainty in coming months is that the MPC will
remain split, and the likelihood remains the majority on the committee
will continue to vote for no change until there is a clearer shift, for
better or worse, in the economic outlook.

The recent, much stronger-than-expected 1.1% rise in Q1 growth was
seen in very different lights by Governor Mervyn King and MPC
Member Andrew Sentance.

Sentance said that “measures of nominal demand have picked up
particularly strongly” and the GDP data “confirmed evidence that has
been coming at us from business surveys for some time.”

King, however, cautioned that “we must be careful not to read too
much into one number. And the wider economic problems around the world
underline the fact that we cannot be confident that the recovery in
demand, output and employment here in the UK will be sustained.”

Sentance has voted in the past two consecutive months for a 25bp
rate hike, and the strong GDP data serve only to reinforce his view that
the economy is rebounding. With inflation expectations having also risen
from the depths of the recession, the time has come to start gently
removing the extreme policy stimulus.

Miles, on the other hand, believes that rather than reduce the
policy stimulus provided by setting Bank Rate at an historic low of 0.5%
and injecting stg200 billion through quantitative easing, the MPC may
have to go further yet.

Miles, a former finance professor, highlighted the tightening in
bank funding conditions and UK credit conditions and the threat posed by
the sovereign debt crisis as downside risks.

“Recent events in sovereign debt markets and in bank funding
highlight the downside risks. Further asset purchases may be warranted
at some point in the future,” Miles stated in his written testimony to
the TSC.

The MPC members who are placing weight on credit and financial
market conditions sound dovish while Sentance, who frequently refers to
upbeat business survey evidence, finds plenty of evidence for
tightening.

Paul Fisher, BOE Executive Director Markets, told the TSC the
economic outlook had weakened in part because of sovereign debt woes and
associated fiscal tightening.

“Recently financial markets (including bank funding markets) have
become more fragile, potentially exacerbating already restricted credit
conditions for households and firms. An insufficient supply of credit –
especially to support investment by businesses – would be a major drag
on the recovery going forward,” he said.

With inflation having come in higher than expected and growth
lower, the MPC’s policy choices have become trickier than ever.

The combination of inflation expectations currently above the 2%
CPI target and subdued wage growth provided ammunition for both sides of
the argument.

One view is that if the rise in inflation expectations is not
driving up wages, then inflation itself will end up coming back down,
bringing expectations lower in its wake.

“Wage growth has been subdued so far and has been held down by the
recession but that won’t necessarily go on forever,” Sentance said.

King, however, believes the subdued wage growth could well go on.

“I myself would be skeptical that this is a period in which you
would expect to see a very significant pick up in nominal wages and
salaries,” King said.

Miles too said he did not believe the most likely outturn was one
where above high inflation expectations become ingrained, although he
acknowledged it would make life difficult for policy makers if they do.

Highlighting the main area of agreement on the MPC, Miles said –
“We remain in a pretty difficult situation with monetary policy.”

With uncertainty abounding and splits on the committee, it was
unsurprising markets showed little reaction to Wednesday’s lengthy TSC
testimony.

Money markets raised expectations of monetary tightening following
the Q2 GDP data, although only modestly, with the sterling overnight
index average currently pricing in a little more than one 25bp rate hike
in the next 12 months.

The TSC testimony, inevitably in light of the divergence of views
on the committee, provided no clear steer on when the next move will
come.

Given the high uncertainty, no action from the MPC looks likely
until at least its November forecast round, with analysts recent median
forecasts suggesting there will be no tightening until the first quarter
of next year.

–London newsroom 0044 20 78627491; email: drobinson@marketnews.com

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