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.

The minutes for the MPC's October meeting were released this morning 

The decision:

The committee voted unanimously to maintain the bank rate at 0.5% and continue with the programme of asset purchases totalling £375bn

There were some differences of opinion on the committee as to whether the asset purchase programme should be scaled up, but there was agreement to continue with the current programme of purchases and wait until there was more information in the next Inflation Report in November.

The background:

Financial markets

• ECB announced a programme of Outright Monetary Transactions
• Federal Reserve announced it would continue to engage in monetary easing until there was a sustained improvement in labour market
• Bank of Japan also announce further stimulus
• Yields on short-term government bonds in Spain and Italy have fallen

International economy

• Output growth soft in many advanced and emerging economies
• In the US employment growth had been weaker than at the start of the year but there were positive signs in the ISM (a leading indicator index similar to the PMI)
• Oil prices fell a little on the month

Money, credit, demand and output

• ONS revised up its estimate for GDP change in the UK in Q2 to a 0.4% contraction
• Net trade was a drag on growth in Q2
• Household credit growth was slow
• FLS likely to have eased access to credit for some households and companies but it is likely to take longer for FLS to feed through to corporate lending

Supply, costs and prices

• CPI fell to 2.5% in August (and yesterday’s figures showed it fell again, to 2.2% in September)
• Higher oil and energy prices will put some upward pressure on inflation
• Employment had continued to grow strongly, but productivity continued to deteriorate
• Factors to explain weakness in productivity could be: problems with access to credit reducing access to capital equipment; uncertain demand meaning firms are hiring new employees rather than investing a large initial layout in capital; low rates of company failure

A bit more good news on the inflation front as CPI edged down again to 2.5% in August. But it's likely future path together with the underlying health of the UK economy and likely global developments are still far from certain. 

This morning's MPC minutes highlight the range of possibilities for all these economic variables through the remainder of this year and the continuing dilemma facing policy makers.

Where does the Committee see inflation heading?

In short the answer is down, but not as quickly as the Committee had been expecting at the time of its August Inflation Report. Some commodity prices had been on the increase due to supply constraints and this, together with expected increases in utilities and food prices would be passed through to consumers later this year.  However, there was still judged to be spare capacity in the economy which would continue to bear down on inflation in the medium term.

What about growth?

Here the picture is a lot less clear.  The Jubilee impacts on GDP should be unwound in the third quarter and a boost from the Olympics should also bring a return to growth in the thiid quarter of this year.  While some business surveys had picked up a little, measures of sentiment appear to be pretty weak.  In addition, firms opting to retain or recruit rather than invest in new plant and machinery would indicate that many are reluctant to commit to increases in capacity in case the demand outlook deteriorates. 

The big international questions remain firmly on the table - where does the eurozone go from here, how will the US navigate its budgetary tightening in 2013 and are emerging economies in for a more prolong period of sub-trend growth?  Since the Committee met we've had more action from the ECB to purchase bonds of struggling countries, which markets reacted positively too, but eurozone politicians still have a mountain to climb in bring stability to the bloc.

A word on FLS

There was a fair amount of emphasis on the role of FLS in boosting borrowing by households and the corporate sector to support investment.  The Committee noted some initial positive signs that it was feeding through to lower lending rates, but acknowledged that this was going to be a long game with banks using the full 18 month window to draw funding from FLS. 

What's new for October?

The decision to proceed with asset purchases announced in July and keep rates at 0.5% was a unanimous one. But for some members:

additional stimulus was more likely than not to be needed in due course

It would, therefore, seem to be a question of when.  The October meeting will see a bit more evidence on whether activity in the UK did indeed pick up in the third quarter as expected.  However, there is unlikely to be a great deal more clarity on prospects for the external environment coming through in the next few weeks. With views that the risks to inflation remain balanced in the medium term, so it would seem the decision on what next for QE will be similarly balanced when the MPC meets again in October. 

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.
  

Yesterday’s inflation figures presented some good news for the MPC. CPI came in at a lower-than-expected rate of 3% meaning – for the first time in this Parliament – that the Governor of the Bank of England did not have to write a letter to the Chancellor of the Exchequer.

CPI inflation is now at its lowest level since February 2010, but it remains well above target, and has been for over two years. 

Yet this morning’s MPC minutes hint that increased monetary easing is more likely than an increase in interest rates any time soon. As with last month, all committee members voted to maintain the stock of asset purchases at £325bn with the exception of David Miles, who voted in favour of a £25bn extension to the scheme.

So given the high level of inflation why is more monetary easing on the table?

The UK economy is still weak. As with last week’s Inflation Report, the MPC’s minutes noted the significant risks to growth associated with the economic turmoil in the Eurozone. Similar points were highlighted yesterday, when the IMF released its review of the UK policy mix. In fact, the IMF argued that weak growth and limited underlying inflationary pressure suggest further monetary easing is required. 

Our own forecasts suggest that growth is likely to be weak, and inflation should fall back to target early next year. However, we now expect inflation to return to target later than we previously forecast, due to the increased outlook for oil and commodity prices: upside risks to inflation remain.

As King pointed out during the press release for the Inflation Report, the amount of spare capacity in the economy is difficult to predict, and will be affected by tight credit conditions and economic uncertainty, yet it is precisely this spare capacity that is expected to keep domestic price pressures under control.

Other upside risks to inflation noted in today’s minutes:

-         developments in global prices, such as for commodities

-         growth in domestic costs

-         degree to which companies seek to restore margins

The minutes also noted some downwards risk to inflation:

-         weak economic activity might result in inflation falling materially below 2% in the medium term

-         demand growth might be weaker than expected

The decision:

The MPC voted to maintain the Bank Rate at 0.5% and continue with asset purchases totalling £325bn

All nine members of the committee voted in favour of maintaining the Bank Rate. Only David Miles voted against maintaining the level of asset purchases, favouring an increase of £25bn.

The committee noted the recent unexpected falls in manufacturing output and construction seen in ONS data this year and thought that this (combined with the mechanical affect of an additional Bank Holiday as a result of the jubilee) might mean that GDP would fall in the first and second quarters of this year. In addition, Euro area instability continues to present a risk to the UK economy. However, it was felt that underlying activity had probably picked up since the second half of 2011.

CPI has started to fall back, though at a slightly slower rate than had previously been expected, meaning the path for inflation was likely to be higher than that forecast in the most recent inflation report.

Upside risks to inflation:

• Rising oil and commodity prices
• Domestic companies seeking to rebuild margins to improve cashflow
• Nominal wage growth outpacing productivity improvements

Downside risks to inflation:

• Demand too weak to absorb the margin of spare capacity in the economy
• Potential for further economic contraction might dampen business and consumer confidence
• Households and businesses building up a buffer of savings might slow growth

Economic developments over the month:

(NB the MPC’s meeting was held before much of the recent escalation in Spanish government bond yields)

Financial markets

• Conditions in financial markets continue to normalise
• Functioning of bank funding markets had improved
• Fall in short-term funding costs in the Euro area

International markets

• Global PMIs suggest that growth rates were similar to those seen in the first half of 2011
• Euro area PMIs, however, suggested that economic activity in the region was weak
• Steps to restructure Greek debt had been agreed
• US growth looking stronger
• Chinese data consistent with gentle slowing in activity
• Oil prices remained elevated, compared with the start of the year but increased little over the month

Money, credit, demand and output

• UK GDP fell in the fourth quarter of 2011
• Manufacturing output fell in February, though this was at odds with more positive business surveys
• Service sector surveys suggest growth in the first quarter
• Construction saw another large contraction, which is likely to depress GDP growth in the first quarter of 2012
• Credit conditions likely to remain tight

Supply, costs and prices

• CPI down to 3.4% in February (since the meeting CPI inflation was reported as 3.5% in March). The fall was a little less than expected
• CPI likely to be higher than previously forecast
• Picture from labour market mixed, with unemployment elevated and wage settlements running at about 2.5%
  

The decision:

The bank rate was held at 0.5% and the asset purchase programme was extended by £50bn to £325bn.

All nine members voted to extend the asset purchase programme. Two members voted for a £75bn increase.

Recent developments:

Financial markets

• European financial markets fared better since the the ECB’s additional long-term refinancing options (LTROs) in December.
• Short-term bank funding markets had also improved.
• Spanish and Italian bond yields had come down, though remained elevated.
• UK short-term interest rates had changed little over the month.
• Equity indices had started to improve.

The international economy

• Upside news on near-term prospects for global economy including positive PMIs.
• US growth looking stronger: 0.7% in 2011 q4.
• Even Euro area PMIs picked up in January, suggesting growth had not continued to weaken.

Money, credit, demand and output

• UK GDP fell 0.2% in the last quarter of 2011, broadly in line with expectations.
• Since then PMIs have improved sharply, though other surveys were weaker.
• First quarter of 2012 may be a little stronger than previously expected.
• Credit conditions for businesses and households remained tight, but bank funding markets improved since the end of the year which could lead to improvement.

Supply, costs and prices

• CPI fell to 3.6% in January, as expected.
• Employment rate broadly flat since November.
• Pay growth remained subdued and expected to remain modest.
• Little significant movement in medium-term inflation expectations.

GDP and inflation projections

• Slight contraction in the final quarter of 2011 followed a period of sluggish growth.
• Monthly indicators pointed to a pickup in output in January.
• There are continued substantial uncertainties surrounding the outlook for growth, most significantly due to developments in the euro area.
• Growth will be dependent on whether households start spending again (as real income squeeze abates); cost and availability of credit; impact of asset purchases on demand.
• Likely path for inflation also highly uncertain, with several unknown factors such as the path of energy prices.

Key risks to inflation

• On the upside:
  - companies’ input costs rising further
  - disruptions to gas and oil supply
  - earnings growth outstripping slow productivity growth
• On the downside:
  - growth too weak to absorb the pool of spare capacity
  - Euro area crisis increasing banks’ funding costs and feeding through into the availability and cost of credit
  - Slower than expected growth in household spending