LONDON (MNI), May 10 – The Bank of England Monetary Policy
Committee’s decision not to extend quantitative easing at its May
meeting marks the start of what, absent an intensification of the
Eurozone crisis, would likely be a lengthy policy pause.

When the first wave of asset purchases under QE1 came to a halt,
back in February 2010, policy was then left on hold until QE2 was
launched in October last year and now the MPC has brought that second
wave to an end. A key concern of some on the MPC, that elevated
inflation could prove more resilient than previously expected, is highly
unlikely to be assuaged near term, with steady policy now the default
setting.

Those analysts who made the minority call that the MPC would extend
QE in May don’t now expect a rapid resumption of asset purchases.

Economists at Investec, for example, who had forecast a QE
extension in May, acknowledged that while it was possible for the MPC to
re-open the QE taps at any time “more realistically the committee has
probably entered a period of wait-and-see.”

There is a consensus view that the MPC will resume QE if the EMU
crisis worsens and domestic activity data take a clear turn for the
worse. There is no division between analysts, or on the MPC, over that.

It’s a commonplace to say intensification of the Eurozone crisis,
feeding through to higher bank funding costs, could re-trigger QE.

One debate, at the margins, is whether the MPC would be at all
likely to sanction more QE if the euro area crisis calms down.

The MPC’s May decision Thursday suggests that the majority on the
commmittee are concerned enough about inflation not falling back below
target, as it had previously forecast, to keep policy on hold even when
the official domestic data are showing the economy back in recession.

The May policy decision reflects the thinking in the April minutes
and in the subsequent public comments made by Deputy Governor Paul
Tucker and MPC member Adam Posen.

This is that the MPC will look through weak headline growth
outturns to what they believe to be a somewhat more upbeat underlying
growth picture and that members are not comfortable with high inflation.

As Posen told reporters last month in Edinburgh – “the economy is
stronger than what the data is going to show” and as Tucker said in a
keynote speech, “the MPC will be focused mainly not on headline growth
but rather on indicators of underlying activity.”

On inflation, although it has “fallen significantly over the past
six months, from over 5% to 3.5% … it remains uncomfortably above
target,” Tucker said.

The concerns raised by MPC members over the increase in unit wage
costs, as a result of weak productivity growth and the attendant risk of
firms’ trying to restore margins, are not going to evaporate any time
soon.

“There was a risk that inflation would fall less rapidly in the
near term than the Committee had anticipated in its February Inflation
Report central projection,” the April minutes said.

Endorsing more QE at the May meeting would have clouded this
“concerned about inflation” message, with the rapid about turn risking
undermining the MPC’s attempt to re-establish its inflation fighting
credentials.

The focus now will be on next week’s May Inflation Report, but it
is likely simply to endorse the MPC’s current decision.

Unlike the division of labour in some other central banks, the
forecasts are not “staff projections” but those agreed by the MPC, using
the central bank’s suite of models and extensive in-house economics
staff.

The MPC is likely to have endorsed an inflation forecast that is
readily compatible with the decision to leave policy on hold, while
leaving the door open to more QE if things take a turn for the worse.

Philip Rush, economist at Nomura, expects the Inflation Report to
show the balance of risks around the inflation target to be broadly
balanced – and Thursday’s decision only serves to endorse this view.

–London newsroom: 4420 7862 7491; email: drobinson@marketnews.com

[TOPICS: M$$BE$]