Bloomberg News

BOE QE May Not Be Enough as Outlook Weakens, ITEM Club Says

October 17, 2011

(Updates with pound, bonds in fifth paragraph.)

Oct. 17 (Bloomberg) -- Ernst & Young LLP’s ITEM Club cut its U.K. growth forecast and said the Bank of England should lower its key interest rate as its new stimulus earlier this month is unlikely to be enough to revive economic growth.

Gross domestic product will increase 0.9 percent in 2011 and 1.5 percent in 2012, compared with July projections of 1.4 percent and 2.2 percent respectively, the research group said in an e-mailed report in London today.

As the euro-area debt crisis roiled financial markets, the Bank of England increased its bond-purchase program to 275 billion pounds ($435 billion) from 200 billion pounds this month. Policy makers from the Group of 20 nations meeting in Paris at the weekend set an Oct. 23 European summit as the deadline for firming up a plan to end the turmoil. The ITEM Club said failure to find a resolution will impact the U.K.

“With the U.K. recovery grinding to a halt, new measures are now needed,” said Peter Spencer, chief economic adviser to the ITEM Club. “We have based our figures on the assumption of an early resolution of the crisis gripping the euro zone, which may prove optimistic in view of the very slow progress made until now. In that case, the outlook for the U.K. would inevitably be a lot worse.”

The pound was little changed against the dollar and traded at $1.5816 as of 9:01 a.m. in London. Bonds declined, pushing the yield on the benchmark 10-year U.K. gilt up 2 basis points to 2.63 percent.

Rate-Cut Call

As well as raising the ceiling of its asset-purchase plan, the Bank of England also held its benchmark interest rate at a record low of 0.5 percent on Oct. 6. While inflation is more than double the central bank’s 2 percent target, policy makers forecast that it will slow “sharply” next year.

ITEM Club’s central forecast assumes that the Bank of England will expand QE further and not raise interest rates until November 2012. Spencer said the central bank can afford to cut its key rate to 0.25 percent as inflation is set to slow. This would provide a “boost to borrowers and potentially help to stimulate consumer spending,” he said.

‘Soft Patch’

U.K. GDP grew just 0.1 percent in the second quarter and data on Oct. 12 showed unemployment rose to 2.57 million in the three months through August, the most since 1994. While growth probably accelerated to 0.4 percent in the third quarter, business surveys indicate there will be a “soft patch around the turn of the year,” ITEM Club said.

“If demand disappears, the private sector could see sizeable job losses” and unemployment will rise to 2.7 million by early 2013, it said.

The government should cut National Insurance contributions paid by employers for staff under 21 years of age and scrap the stamp duty property-transaction tax for first-time homebuyers to boost the housing market, ITEM Club said. The Engineering Employers Federation also called on the government to take additional steps to aid the economy. In a statement today, it recommended increasing tax credits for companies and expanding measures to provide funding for smaller businesses.

Separately, the Centre for Economics and Business Research Ltd. lowered its 2011 growth estimate, to 0.6 percent from a previous range of between 1 percent and 1.5 percent. It sees the Bank of England raising its bond-program target to 300 billion pounds by end-2012, and said a “severe financial crisis” could push it to as high as 400 billion pounds.

--Editors: Fergal O’Brien, Eddie Buckle

To contact the reporter on this story: Scott Hamilton in London at shamilton8@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net


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