By David Thomas

LONDON (MNI) – The Bank of England’s Monetary Policy Committee had
already been seen as set to expand further its asset purchase programme
in November.

A shift in the market spotlight to potential fiscal policy
changes in recent days will only reinforce those expectations.

The recent Q3 data flow has confirmed a much-anticipated bounce
back in activity from a Jubilee-dampened Q2. Looking through that – as
the MPC should and will – to the underlying picture only confirms that
the economy continues to more or less stagnate.

The latest IMF forecasts suggest the UK would be lucky to
stagnate, but BOE Executive Director Markets Paul Fisher accused the
Fund of sending out negative vibes in an interview with BBC Radio
Scotland earlier this week.

“If you strip out some of the special factors affecting the economy
this year like the Royal Wedding (2011 base effects?), the Jubilee and
the Olympics basically the economy is flat this year and we’ve known
that for some time.”

Reckoned a slightly dovish MPC voter, Fisher is most likely one of
those who are described in the last published set of MPC minutes as
feeling “additional stimulus was more likely than not to be needed in
due course”.

It is a safe bet that BOE Governor Mervyn King is also a member of
that group. But the governor gave nothing away in terms of the immediate
policy outlook in a largely academic speech here last night. At the same
time he offered no clear push-back either to the near assumption in the
market that there will be more QE this autumn.

There is no theoretical limit to QE, King reiterated – although he
also harped on the limits of what monetary policy could achieve. Unlike
the 1930’s though at least monetary policy is not part of the problem.

King has been happy since the election of a deficit-cutting
Tory-Liberal coalition in 2010 to allow an ultra-loose monetary policy
to compensate for the impact of austerity.

The spotlight is now moving back to fiscal policy with the approach
of Chancellor of the Exchequer George Osborne’s December 5 Autumn
Statement and speculation that he will be forced to ditch his target of
getting debt on a downward trajectory by 2015-16.

Speculation of a UK downgrade is modish again and many in the
markets are scenting blood in the water. That said, others point out
that the euro zone crisis is not going away in a hurry meaning the UK’s
relative safe haven status should be safe for a while.

Optimists also point to the way in which Treasuries rallied
following S&P’s recent US downgrade.

The possibility of an official change to the RPI measure of
inflation will go ahead seems a more likely sell-off trigger than a
downgrade. The move could potentially slash investors’ returns from
linker gilts and is fomenting serious angst among some market players.

Chancellor of the Exchequer George Osborne addressed that market
skittishness on Monday when he told the ruling Conservative party
conference that he would stick the fiscal course and ambitiously
talked of squeezing a further stg10bn from welfare reform.

On the possible ditching or stretching of the debt target he was
unsurprisingly coy. But the strategy seems simple enough – keep to the
path of downsizing government over the medium run but let the automatic
stabilisers run wild in the short.

King had already sent a public signal via a Channel 4 interview on
Sept. 20 that this is a fiscal approach he could live with.

“If it’s (missing debt targets) because the economy has grown
slowly, yes indeed, that was always part of the plan. If it’s because
the world economy has grown slowly and we in turn have grown slowly then
it would be acceptable to be in that position.”

It was a theme endorsed by Prime Minister David Cameron in his
‘hour of reckoning’ speech today. Any dilution of Plan A would bring an
end to the current historically low level of interest rates, Cameron
warned – soothing muzak for the MPC.

To quote Fisher in Scotland again:

“They do have to keep a credible programme for the fiscal finances
so that markets believe that they are going to repay their debt. As long
as they do that there is plenty of room for debate between the political
parties,” he said.

So fiscal policy will more likely oil the rails for further QE than
get in the way. MPC members will no doubt insist they remain
focused on the medium-term inflation outlook and the data flow when it
comes to authorising any further easing of the monetary stance.

Central banks can’t live by inflation targeting alone. That was
the leitmotif of King’s speech to the London School of Economics
last night.

But the MPC’s recent reaction function shows (October 2011,
February 2012) that it can respond very promptly indeed when it sniffs
threats to financial stability issues in the air.

–London Newsroom: +4420 7862 7492; email: