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Preview: BOE rate/QE decision

Thu, Nov 5 2009, 09:52 GMT
by RANsquawk Research Team

RANsquawk

Rates are currently 0.5% (all analysts going for unchanged)

QE currently stands at GBP 175bln (consensus for GBP +50bln, ranging from unchanged to GBP +50bln)

King(dom) of QE

Despite widespread disparity concerning the accuracy of the -0.4% Q3 GDP data, there is a growing agreement between finance professionals that the BoE will vote to expand the size of its QE program. However this time it seem that the decision will be mainly driven by the mounting political pressure from the UK government and not objective investigation of current economic conditions. The MPC requires the Chancellors authorisation to go ahead and print money and now it seems that Mr Brown has joined the party and decided to voice his opinion on the monetary policy. Mr Brown said: I will fight over the next few months for what I believe. Over the next year, the pursuit of growth in the context of a deficit reduction plan that is sensible is the only way to avoid a decade of hardship. This puts the Bank in difficult position and thus it seems unlikely that the MPC will be able to steer away from leaving the program unchanged.

Not so long ago market participants were forced to revise their expectations following worse than expected UK GDP data. So much so that prior to the release, the consensus was that the BoE would hold fire and allow the process of gilt buying to at least pause for the time being. Now two thirds of all City economists think the Bank will announce more QE. In support of QE, the Bank will be able to cite mixed economic data as well as the still impaired credit system. Still, the latest manufacturing survey raised hopes that Britain might finally see economic growth in theQ4. Elsewhere, inflation fell by more than expected to 1.1% in September due to shrinking energy prices. But September may prove to be the floor in annual CPI since oil prices fell sharply in the final months of 2008. As a result, annual CPI is likely to rise back above the Banks 2% target in the near future. There is a brief window of opportunity to ease unconventional policy yet further before rising base effects and the reversal of last years VAT cut take effect. The result of which is likely to be a sharp rise in headline inflation data.

Money supply is becoming a lot like Santa Claus, only exists in fairy tales

Appalling lending figures are perhaps the strongest indication yet that QE has failed to stimulate broad money and credit growth. Despite aggressive actions by the Bank, the program has failed to address the fundamental problem of credit availability. As such, the MPC may debate turning to alternative measures and follow the Riksbank’s initiative and charge banks that hoard their cash. However, the Bank may feel that it would rather buy more time in hope that green shoots become greener in the future and simply expand the program instead of risk looking somewhat desperate in the eyes of investment public.

Given risks that insufficiently stimulatory monetary policy would further depress inflation expectations and harm public confidence in the recovery means that the Bank must proceed with caution. Also, the official figures are yet to show that path towards recovery has found firm footing. As such, the MPC must be wary of an adverse market reaction should they pause QE so they could be hesitant to stop the purchases altogether. This lends to the belief that an extension by a further GBP 25-50bln, coupled with smaller sized purchases or a move towards private sector bonds instead may be a fitting forecast. At the same time, further extensions of QE run the risk of shaking investor confidence by underscoring the severity of economic challenges. Any extension to the program would pressure GBP, while Gilts are likely to move higher. However, substantial gains are most likely should the program be expanded by more than GBP 50bln.

Economist views

Seven of the nine Times MPC committee members call for an extension of QE. Four want GBP 25bln, one for GBP 30bln and two for GBP 50bln jump. The other two members voted for no change. The Times MPC was almost unanimous in its recommendation that interest rates should stay at its historically low level of 0.5%. However, Anatole Kaletsky was the only member to advocate a change in the base rate, arguing that it should be halved, to 0.25%. Amongst the Shadow MPC there is a widespread view that QE needs to be extended for some months beyond November. Also, former BOE member Blanchflower calls for a GBP 50bln extension to QE.

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Published on  Thu, Nov 5 2009, 09:55 GMT