EEF blog

The Decision

Bank rate held at 0.5%

Stock of asset purchases held at £375 billion.

The Discussion  

Financial markets

• Relatively limited reaction from financial markets to Cyprus bailout
• Equity markets continued to be buoyant, some major international equity indices at all-time nominal highs
• Little reaction to UK being placed on negative watch by Fitch

International economy

• Global growth continues to show gradual recovery with world trade and investment  picking up in early 2013 but pattern of growth remains uneven
• Tentative signs of strengthening confidence in the Euro area have  not been maintained
• US indicators positive with robust consumer spending, a strong housing market and growing employment despite more restrictive fiscal policy.
• Asia still showing evidence of expansion with Chinese PMI rising in March and business confidence improving in Japan.

Money, Credit, Demand and Output

• Turning to the UK, there is mixed news of activity in the first quarter of 2013 from official indicators
• Credit conditions have eased with the supply of credit increasing and some feed through in loan rates. However small companies continue to report more difficulties accessing finance and there has been little sign that easing of credit access has fed through into higher net lending to businesses.
• There is some evidence of increased supply of credit feeding through into the housing market.
• The committee agreed that a well-capitalised banking system is important for the capacity of the economy over time and saw merit in boosting lending through an extension to the FLS.

Supply, Costs and Prices

• Inflation expected to remain high, rising to 3% in the middle of the year
• Pay growth has continued to be weak
• Productivity remains puzzling as employment continued to increase despite falling output. Relatively low company failure due to low nominal interests rates and forbearance by lenders was discussed as one of the factors contributing to low productivity.
  

The minutes of the MPC meeting on 6 and 7 February show MPC members voted to maintain the bank rate at 0.5 and hold the level of quantitative easing at £375 billion.

Key points:

Financial markets

• Improved sentiment that has been showing through in financial asset prices since the summer has been sustained. 
• Accommodative policies of major central banks and the view that major downside risks had lessened improved prospects for a recovery in the global economy.
• Most major equity indices were close to post-crisis highs with strong rises seen in the UK, US and Japan

International economy.

• Overall there are few signs that improved sentiment is translating through into improved economic data.
• The US experienced a small contraction in q4 GDP but other economic indicators provide a more positive picture of the health of the economy.
• The Euro area contracted at the end of last year but the pace of contraction may be starting to ease.
• A fiscal stimulus package has been confirmed in Japan along with further rounds of asset purchases.
• China shows signs of returning to robust growth.

Money, credit, demand and output

• GDP contracted in q4 2012 as global uncertainty depressed industrial production and UK exports.
• Bank lending remained weak. Some signs that the FLS is having an impact and improvement has been seen in the housing market.
• Lower spreads on bank loans and increased availability of credit have been seen for large corporations but this is not as evident for small businesses.
• GDP is expected to remain weak in the near term with a slow but sustained recovery expected over the next three years as domestic credit conditions and the wider global economy improve.
• GDP expected to remain below the pre-crisis level until 2015.

Supply, costs and prices

• CPI inflation is expected to rise in the near term due to higher oil prices – which had risen 4% since the MPC’s last meeting – and the Sterling’s recent depreciation. Inflation may remain above the 2% target for the next two years.
• Private sector pay growth is expected to be close to 2% in the coming year and surveys suggest employment growth may be moderating.
• February’s Inflation Report outlined the expectation that output would continue a gentle recovery and productivity would increase, lessening unit wage costs. There is a lot of uncertainty around this view relating to productivity and demand growth.

The decision

MPC members decided to hold both the bank rate and the stock of asset purchases at their previous rates. The decision regarding the bank rate was unanimous but three people did vote in favour of increasing the size of the asset purchase programme by a further £25 billion, including Governor Mervyn King. This was unexpected and has been seen as a bit of a turnaround given that he has previously questioned the value of further quantitative easing saying it will have little impact on growth.

MPC members voted to hold the bank rate steady at 0.5% and to finance a further £50 billion of asset purchases that will take place over the next four months.  This decision brings the total quantity of quantitative easing to £375 billion. 

All nine members of the MPC voted to maintain the bank rate at 0.5%.  Seven members voted in favour of increasing the stock of asset purchases, with Spencer Dale and Ben Broadbent preferring to maintain the stock of asset purchases at £325 billion.

The fall in inflation to 2.4% announced yesterday was not unexpected by the MPC given reductions in oil and energy prices and the impact of the delay to fuel duty changes.

The Committee noted higher risks from weakening in global demand, outlook for GDP growth and export prospects.  While the reaction to the European council meeting has been generally positive and has led to improved market sentiment in Europe, there are increasing signs that the threat of disorderly resolution to the financial tensions in the euro area is affecting UK growth. The majority view was that upside risks to inflation had declined and the potential cost of greater stimulus was lower than the cost of providing too little. 

Economic developments over the month:

Financial markets

• The prevailing sentiment in financial markets remains one of caution and risk aversion.
• Some improvement in bank funding markets in continental Europe towards the end of the month.

The international economy

• Recent indicators continue to suggest a weak near-term outlook for global activity. 
• Composite Euro area PMI rose fractionally in June but remained consistent with contraction in the second quarter.
• Forward looking service sector business expectations suggest weak third quarter. 
• US manufacturing ISM index for June fell sharply indicating flat or declining output in the sector and the new orders index also contracted suggesting weakness could persist.
• Overall picture for emerging economies one of gradual reduction in the pace of growth. 
• Oil prices continued to decline for most of the month before picking up a little towards the end of June and early July.

Money, credit, demand and output

• GDP estimate unchanged but contribution to growth from trade, business investment and consumer spending were revised down and offset by an increase in government spending.
• Business survey indicators of activity have been weak. 
• The announcement of the Funding for Lending Scheme and the Banks activation of its ECTR facility are expected to provide a potentially significant stimulus to economic activity.

Supply, costs and prices

• CPI had fallen to 2.8% in May (though has since fallen further to 2.4% in June)
• CPI likely to be lower than expected in the near-term given low oil and energy prices and postponement of the fuel duty changes. 
• Private sector productivity had continued to fall despite a three month on three month rise in employment of 166,000 in April.
  

This is a summary of the MPC minutes - you can find the full version here. 

Financial markets

• Increased stress in financial markets associated with euro governments and banks is reflected in volatility in asset prices and a reduction in liquidity across a range of markets.

• Stresses on short-term funding markets are driving up costs for European banks, including UK banks. Domestic lending in the UK could be affected if higher costs persist.

International economy

• European activity indicators have weakened, particularly in the periphery, but indicators even for France and Germany suggest flat output.

• U.S. indicators mixed with encouraging signs of investment in quarter 3 like to be short-lived as business and consumer confidence are weak. The passage of Obama’s $450 billion stimulus bill through Congress looks uncertain.

• Some gradual slowing in activity in China. The rebound in activity in Japan following the earthquake and tsunami also looks to be short-lived with weak prospects beyond 2011q3.

Money, credit, demand, and output

• The latest revisions to national statistics have revised up the contribution of net trade to growth from the onset of the financial crisis through the recession and into the recovery. This is now more in line with what was expected given the depreciation in sterling.

• Business surveys suggest weak growth in 2011q3 in both services and manufacturing sectors.

• Mixed evidence on the weakening of external demand for UK exports with CIPS/Markit PMI suggesting falling demand but other surveys suggesting this is holding up, particularly to markets outside Europe.

• Credit conditions have remained tighter since the financial crisis but no sign yet that recent financial market turbulence has tightened conditions still further.

Supply, costs, and prices

• MPC expected inflation to rise above 5% in the short term [as it has, to 5.2%] before falling back sharply in 2012 as VAT and oil price rises fall out of the series.

• Inflation expectations as measured by surveys of households remain unchanged while implied expectations through financial markets have fallen somewhat – though such implied expectations are volatile in times of financial stress.

• Excluding the impact of bonuses in some sectors, recent data suggests wage growth remains modest.

• The degree of slack in the labour market is a key factor in determining how much additional downward pressure there will be on  inflation.

Immediate policy decision

• The main upside risks to inflation in the medium term are expectations of higher inflation becoming embedded in wage and price-setting behaviour, lower spare capacity in the economy than thought, and another rise in commodity prices.

• No recent data suggest any strengthening in the upside risks.

• The main downside risk to inflation in the medium term is weak demand being unable to absorb the spare capacity in the economy.

• Ongoing problems in the eurozone area and the strains these are putting on financial markets have increased recently and the outlook for the UK economy had weakened.

• The MPC voted unanimously for Bank Rate to be maintained at 0.5% and also unanimously to finance a further £75 billion of asset purchases (QE).