LONDON (MNI), Aug. 5 – The Bank of England’s Monetary Policy
Committee is split and, as MPC member David Miles said recently, “in a
pretty difficult situation,” faced by large upside and downside
inflation risks.

A Market News poll found analysts’ median forecast was for the MPC
to leave policy unchanged this year, with near equal numbers predicting
the first Bank Rate rise in either Q1 or Q2 2011.

Despite MPC member Andrew Sentance breaking ranks and voting for a
25 basis point hike at the MPC’s June and July meetings, the continuing
trend has been for analysts to push back their predictions for the
timing of the first hike.

At the August meeting, MPC members will have at hand key growth and
inflation projections from the quarterly forecast round for the August
Inflation Report. These will, almost inevitably, show near-term
inflation coming in markedly higher than the BOE previously predicted
and growth lower.

Former MPC member Charles Goodhart said at a recent event, Fathom
Financial Consulting’s Monetary Policy Forum, that if he was on the MPC
today he would choose the ‘Rip Van Winkle’ option, of going to sleep for
years to avoid unpleasant reality – in this case sluggish growth and
persistent inflation.

While Sentance looks at business surveys and sees evidence of a
relatively robust recovery, Miles, along with other MPC members
including BOE Governor Mervyn King, see downside growth risks and
continuing financial market fragility.

“We remain in a pretty difficult situation with monetary policy
… there are two risks and they are both big risks,” Miles told the
Treasury Select Committee.

The risks Miles identifies are, on the upside “with inflation
having been above the target for an uncomfortably long time now it may
become ingrained in people’s expectations and be difficult to bring
down.”

On the downside “a risk that the growth which we have seen might
dwindle, peter out, the amount of slack in the economy may not fall back
and underlying inflation pressures may fall to a level that takes
inflation beneath the target.”

The surge in headline Q2 growth, with GDP rising 1.1% on the
quarter, is unlikely by itself to resolve the debate on the MPC one way
or the other.

Sentance told the TSC “the UK economy has turned round and measures
of nominal demand have picked up particularly strongly” and the Q2 GDP
data “confirm evidence that has been coming at us from business surveys
and other sources for some time.”

King, however, took a much more cautious view.

“We must be careful not to read too much into one number. 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,” he said.

Private sector economists pointed out that up to half of the Q2
growth could be attributed to increases in public spending – a legacy of
the fiscal easing from the previous Labour administration – and they see
growth dropping back to around 0.5% or 0.6% on the quarter in Q3. The
latest batch of purchasing managers (PMI) surveys, showing growth
slowing at the start of Q3, reinforce the view Q2 may be as good as it
gets.

In its May Inflation Report, the BOE’s implied growth projections
was for GDP to rise at close to 3.5% in 2011 and just above this in
2012, well above consensus forecasts.

The independent Office for Budget Responsibility, for example,
predicts the UK’s 2011 growth will come in at 2.3% and 2.8% in 2012.

Economists at Investec say while they do not expect the BOE to
bring its growth forecasts down to OBR levels in the August Inflation
Report, they do expect it to narrow the gap and one consequence of this
will be to bring down the inflation forecast further out.

The BOE’s May Inflation Report did not factor in the new
government’s plans to hike VAT from January, and now there is a new risk
of a spike in food price inflation, with wheat prices climbing at a
record pace in light of the massive Russian crop failures this summer.

In the August report, the BOE is likely to push up its near-term
inflation forecast and bring down its medium term forecast, intensifying
the MPC’s policy dilemma.

The BOE’s May Inflation Report showed, on market rate expectations,
CPI falling from 3.3% in Q2 this year to just 1.36% two years ahead and
1.75% three years out.

If the August report does cut the growth forecast, the two year out
inflation forecast could be even further below the 2.0% target,
supporting the case of the majority on the MPC who want to look through
the high near-term inflation outturns.

Analysts consensus view is the MPC at its August meeting will
repeat the outturn of its July meeting – leaving policy on hold and
Sentance isolated. With newcomer Martin Weale attending his first
meeting, the expectation is for an 8-1 vote in favour of no change.

The MPC decision will be announced at 1100 GMT Thursday.

For more information contact UK editorial on 44-20-7862 7491 or e-mail:
drobinson@marketnews.com.

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