LONDON (MNI) – The Bank of England is set to raise its inflation
forecasts in the February Inflation Report but is still very likely to
show CPI below 2% two years ahead, leaving scope for more quantitative
easing.

A projected narrow undershooting of the target, however, would not
make further QE a done deal and would leave analysts debating how much
more, if any, QE there is to come.

The hardest part for analysts is reading across from the Inflation
Report projections to MPC policy. In October, the MPC sanctioned far
less QE than its central projections in November implied and in the
first wave of QE sanctioned a final Stg25 billion when on unchanged
policy CPI was expected to overshoot target.

Bank of England Governor Mervyn King’s open letter published
Tuesday reaffirmed the MPC’s view that inflation is heading down, but
there was little precision in his wording.

“The Committee’s best collective judgement is that inflation will
fall back sharply in the next six months or so, and continue falling
thereafter to around target by the end of next year,” he said.

That wording was very similar to that used in his open letter back
in November

“Inflation will fall back sharply in the next six months or so, and
continue falling thereafter to around target by the end of next year,”
the November letter said.

The November Inflation Report showed King’s use of “around target”
is fairly loose.

The November reports’ central, modal projection showed CPI falling
to 1.72% by the fourth quarter of 2012 before hitting a trough at 1.21%
in Q2 2013 and edging up to just 1.27% two years ahead. That was a
record projected undershoot, raising questions over why the MPC’s policy
stance was not looser.

This time around analysts expect the two year ahead forecast to
again be below target, but substantially higher than November’s 1.27%.
On the November projection, CPI two years out from February nudges up to
1.32% and is shown on a gently upward sloping path.

Since November, the MPC has sanctioned another Stg50 billion of QE.
A BOE working paper, published in January, ran a range of models on the
impact of QE and said its preferred average estimates showed that the
first Stg200 billion of QE, at peak, added 1.25 percentage points to
CPI.

Using that assumption as a ready reckoner entails the extra Stg50
billion of QE would add 0.31 percentage points to CPI. That alone would
push the central projection up to just above 1.6% two years ahead, if
nothing else changed.

MPC members, however, believe that things have improved since the
MPC first sanctioned QE in October and since the November Inflation
Report.

MPC member Adam Posen told reporters back on January 23 that “there
are four material ways in which, at least, downside risks have been
materially reduced.”

The first two of these were the MPC’s decision to sanction more QE
and the European Central Bank’s Long Term Repo Operation which “may not
solve everything but it certainly removes for a reasonable length of
time some of the downside risks and makes things better.”

The third improvement Posen cited was the clear pick-up in overseas
economies.

“There has been genuine upside news, or at least the
potential for upside news, in places outside of Europe and the UK,
particularly the US, and in terms of how smoothly the China economy is
slowing down,” he said.

His fourth improvement, linked to the ECB’s LTRO actions, was that
bank funding markets are no longer frozen.

The overall impact of these improvements is not, however, likely to
amount to much on the central growth and inflation projections.

Some of the more extreme risks emanating from the Eurozone,
including a banking sector funding lock-up, were excluded from
November’s central forecast and with the BOE set to adopt the same
approach in February, the diminution of these risks won’t impact the
central projections.

George Buckley, economist at Deutsche Bank, says he expects the BOE
to raise its CPI forecast by some 0.2 percentage point at trough and by
0.3 percentage point at the two year horizon. This would reflect the
impact of QE without significant change to the other inflation numbers.

Buckley notes that the latest inflation data show CPI declining as
the BOE expected, and arguably even better when seasonal factors are
considered, so there is no pressure on the MPC to alter its thinking.

The BOE’s 2012 November growth forecast is well above consensus,
but the improvement in the global economy and the strong January
activity data may prevent it from being cut much, it at all.

The November projection was for 0.9% growth this year, with flat
growth in both Q4 last year and Q1 this.

“There have been a couple of things that have changed the outlook:
the ECB stuff, the reaction to it in markets, but as far as growth in Q4
and Q1 is concerned, that is the near term picture, I don’t think much
has changed since November,” MPC member Ben Broadbent said in a Jan 19
interview with Market News.

The average independent forecast for 2012 growth in the Treasury’s
survey is just 0.4%, with the OECD forecasting just 0.5%.

The MPC, however, takes a robustly independent view and in the past
has shown a willingness to stick to well above consensus numbers.

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

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