–July Minutes: Near Term Inflation Forecasts Too Low, Growth Too High
–Sentance Backs Hike But Minutes Show Easing Back On The Agenda

LONDON (MNI) – Bank of England Monetary Policy Committee members
acknowledged at their July meeting what many other forecasts have long
been saying – the BOE’s projections for near-term inflation have been
too low and its growth outlook overly optimistic.

The MPC will cut the growth forecasts in the August Inflation
Report and, with members worrying about elevated inflation expectations,
the spectre looms of the committee splitting three ways. The July
minutes revealed the MPC mulled the case for modest easing and modest
tightening, although the final vote was the same as in June, with seven
members voting for no change and only Andrew Sentance voting for a hike.

But the minutes have highlighted the potential for wider dissent
within the committee in the coming months as financial markets remain
turbulent and the prospects for a sustained and solid recovery look
less certain.

The MPC looked at the case for “modest easing” and “modest
tightening”, with the arguments for easing that the “softening in the
medium term outlook for growth” would add to downward inflation pressure
and that pay growth has been subdued despite high inflation outturns.

On the hawkish side there was the resilience of UK inflation, the
fear inflation may continue not to respond much to spare capacity in
the economy and the robustness of international and domestic demand.

In a Dow Jones interview published Tuesday, MPC member Adam Posen
said policy could go either way – if things get worse “we have to try to
act” and if they don’t deteriorate then the arguments for tightening
become relevant, with the odds more in favour of easing than tightening.

Posen said the MPC’s inflation projections suggest a “more than 50%
likelihood in my estimation the right next move will be to loosen rather
than to tighten” policy, he told the newswire.

For the majority on the MPC, it seems unlikely they will sanction
near-term tightening.

The MPC members who wrestle on a daily basis with financial markets
and the banking system, Executive Director Markets Paul Fisher and
Deputy Governor Paul Tucker, will be only too aware of the stresses
still out there and Governor Mervyn King has put himself in their camp.

When Sentance first publicly backed a hike in June, Fisher was
quick to publish comments warning against premature tightening.

“Stresses in financial markets had persisted during the month.
Measures of volatility and spreads on a range of riskier assets had
remained high,” with bank funding markets impaired, the minutes said.

“A range of economic data had been released during the month that
were interpreted as signalling that the pace of economic recovery was
likely to be slower than previously expected, particularly in the United
States,” the minutes said.

The BOE’s implied growth forecasts in its May Inflation Report for
2011 were not only above consensus, but above those of the supranational
bodies such as the International Monetary Fund and the Organisation for
Economic Co-operation and Development and the newly formed Office for
Budget Responsibility, whose forecasts the Treasury now uses.

The implied BOE forecast for growth in 2011 was 3.4%, more than a
full percentage point above the OBR’s 2.3% forecast.

The MPC will have to factor in the full impact of the fiscal
tightening in the emergency June budget into its August forecasts,
although Posen told Dow Jones the impact on growth may not be that
great.

Posen said that the negative impact of the tightening “will be a
little bigger in the next 18 months than we had built into our forecasts
…The difference we’re talking about is in tenths of a percent of GDP,
not in whole [percentage] points of GDP, and in relatively few tenths of
a percent,” he said.

While inflation both near-term and going into 2011 will be driven
up in part because of the looming VAT hike at the start of next year,
the inflation forecast at the end of the two-year forecast horizon
could well be brought down.

David Page, economist at Investec, said the implication of the
lower growth forecast would be a rise in downside inflation risks and
quite probably a reduction in the central inflation forecast further
out.

The combination of higher-than-expected near term inflation and
lower than expected growth will be an uncomfortable combination for the
MPC.

The majority, however, are likely to continue to take the view in
coming months that “wait and see” is the optimal policy response, with
markets currently pricing in no change in policy this year.

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

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