London (MNI) – The Bank of England should start tightening monetary
policy in the second half of this year, earlier than markets are
currently anticipating, according to the Organisation for Economic
Co-Operation and Development.

In its latest economic outlook, published Wednesday, the OECD said
the BOE’s current policy stance was appropriate but that the bank should
look to lower the level of quantitative easing and start to normalize
rates in the second half of 2010. Markets recently have sharply scaled
back expectations of higher rates this year, putting little more than a
1 in 10 chance on a single 25-basis-point hike by the end of December.

“With the Bank of England’s policy rate close to zero and
quantitative easing amounting to stg200 billion (14% of GDP), monetary
policy remains highly expansionary. This is appropriate as the large
output gap and falling unit labour costs are expected to underpin a
slowdown in inflation to below the 2% target during 2011,” the OECD
said.

The organization added, however, that “in response to the expected
gradual rise in underlying inflationary pressure as the recovery gathers
pace and to anchor inflation expectations, the normalisation of interest
rates and the scaling back of quantitative easing should start during
the second half of 2010.”

The OECD said that if the pace of fiscal tightening were stepped
up, this would “leave room for a more gradual normalisation of monetary
policy.”

The OECD predicted a pickup in UK growth, projecting it to climb
from 1.3% this year to 2.5% in 2011, and from 2.2% on the year in the
fourth quarter of this year to 2.6% in Q4 2011.

The OECD’s growth projections are softer than the BOE’s, with the
latter forecasting 2.8% growth on the year in Q4 of 2010 and 3.5% in Q4
2012.

Private consumption growth is expected to accelerate sharply in
2011 compared to this year, from 0.3% to 2.2%. Final domestic demand is
expected to rise from +0.7% this year to +2.1% in 2011.

“The recovery is gaining traction, supported by improving financial
conditions, rebounding exports and a temporary surge in stockbuilding,”
the OECD said.

While elevated inflation and the effects of the credit crunch will
keep growth subdued this year, the OECD predicts the recovery will
gather pace next year, bolstered by a acceleration of household
consumption and business investment.

The OECD predicts UK unemployment is already around its peak and
will fall back after the mid-point of this year.

Echoing the BOE’s central view in its recent Inflation Report, the
OECD predicts inflation will drop back below target due to the high
degree of slack in the economy.

It also endorsed the view of the new UK government that further
fiscal consolidation is required, saying that “a concrete and
far-reaching consolidation plan needs to be announced upfront.”

“While monetary policy should remain expansionary over the forecast
period to support activity against the background of low levels of
resource utilisation, the process of normalisation of interest rates
needs to start soon in response to the expected gradual rise in
underlying inflation,” the OECD concluded.

–London newsroom: 4420 7862 7491; e-mail: drobinson@marketnews.com

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