Bank of England policymakers begin a two day meeting today to decide the fate of benchmark interest rates. That’s nothing new. What is new is the rising dissension and confusion among central bankers regarding the direction of near term monetary policy. This division may support the narrowest vote in five months among officials, who were expected to keep policy stable for the foreseeable future.
Leading up to the two day meeting, everyone in the market saw a brighter future for the British economy. The sentiment was sparked by a surge in manufacturing in July. The monthly figure strengthened the most in a decade, rising by 3.2%. By comparison,US manufacturing was relatively flat. Subsequent industrial output figures that surged the most in more than 25 years helped to buoy sentiment. Moreover, expansion seemed to have returned to Europe’s second largest economy. Third quarter growth jumped by 1%, bucking the recent recessionary trend. The strongest growth in five years helped to lift the UK economy on the annual figure and downgraded any real need for further monetary stimulus.
However, the situation has changed over the last month or so, with cracks seen in once viable economic sectors. Manufacturing reversed course in the last two months, remaining sub par along with retail sales that slowed in October. In addition, housing prices fell for the 4th time last month, as industrial output slumped. Even worse, speculation is now emerging that the GDP surge in the third quarter may be a one off event, bolstered by Olympic activity and not organic economic growth.
The slowing pace of growth has sparked a difference of opinions and muddled the direction to which the Bank of England will steer short term monetary policy. Now, central bankers are mulling over the effectiveness of a ninth bout of monetary stimulus, rather than keeping interest rates and asset purchases untouched. Governor Mervyn King has noted that further monetary easing won’t be as forthcoming, noting that the Monetary Policy Committee is likely to “think long and hard” over the possibility of expanding its already 375 billion pound asset purchase program –which the bank recently finished last week.
As a result, a probable conclusion involves the BOE standing pat on monetary policy for the moment, a similar situation that the central bank faced in the summer. With a vote of 5-4, central bankers kept the asset purchase facility on target, while maintaining the benchmark rate. The lone caveat remains the Funding for Lending program. Policymakers will want to wait and see how the 3 month old program –which affords cheap credit to businesses – does before making a definitive vote for more QE.
Regardless of the outcome, market expectations will remain bearish over the British pound as expectations of a UK recovery dissipate.