Bloomberg News

King Seen Signalling QE an Option as Euro Tensions Flare

May 11, 2012

Bank of England Governor Mervyn King may leave the door open to add more stimulus as a flare-up in Europe’s debt crisis and government spending cuts threaten to keep Britain’s recovery at bay, according to economists at Deutsche Bank AG and BNP Paribas SA.

King will next week lower U.K. growth forecasts in the central bank’s Inflation Report, they said, leaving policy makers leeway to restart so-called quantitative easing again if needed. Officials halted it yesterday, pushing up the pound and sending bonds lower.

The Monetary Policy Committee held fire on more bond purchases as concern among some officials about inflation mounts. Signaling that QE is off the table on May 16 could further boost the pound, adding to pressure on the U.K. economy, while the Bank of England may also favor keeping the door open as tensions in Europe’s debt crisis increase.

“They’ll have no choice but to revise down their growth projections,” said George Buckley, an economist at Deutsche Bank in London. “They have a dilemma of high inflation and very weak growth, but you definitely can’t rule more QE out.”

Other central banks are also trying to steer a path between inflation and growth. European Central Bank President Mario Draghi last week left open the option of further stimulus if the euro-area economy continues to deteriorate, pointing to new forecasts next month that may change the policy stance.

Norway’s central bank left its key rate unchanged at the lowest in two years yesterday, favoring curbing krone gains to protect the economy over tackling an overheated property market.

Pound Gains

Unlike the last time the bank halted quantitative easing in February 2010, the central bank didn’t issue a statement yesterday. Buckley at Deutsche Bank said that could indicate a split on the MPC. While David Miles was the only member to vote for more stimulus in April, Martin Weale has since said that data showing the U.K. slipped back into recession strengthened the argument for more QE.

Indications from the Bank of England that more QE is possible may help cap gains by the pound and protect export competitiveness. Sterling has gained 4 percent against the dollar this year and is up against all 16 currencies tracked by Bloomberg. It strengthened against the U.S. currency after yesterday’s central bank announcement, while gilts fell, pushing the 10-year yield up the most in almost eight weeks.

“The U.K. needs a low pound to support exports,” said Michael Saunders, an economist at Citigroup Inc. in London. “If the MPC acquiesces in a rising pound, prospects for U.K. growth, which already are pretty poor in our view, will likely worsen.”

Confidence Falls

The pound weakened against the dollar and the euro today after reports showed U.K. house prices fell in April and consumer confidence dropped. It slipped 0.2 percent to $1.6111 as of 8:04 a.m. in London.

Britain’s recovery remains at risk as Prime Minister David Cameron pushes on with budget cuts to reduce the deficit and unemployment near a 16-year high damps consumer spending. Nationwide Building Society’s index of consumer confidence fell in April, leaving the gauge more than 30 points below its average over the last decade.

The National Institute of Economic and Social Research said yesterday that the economy remains “weak” and the recovery won’t take hold until 2013. Renewed tensions in the euro area, where a Greek political stalemate has raised concerns the country may leave the bloc, may add to headwinds.

‘Dovish Assessment’

David Tinsley, an economist at BNP Paribas in London, said the Inflation Report will present a “fairly dovish assessment” of the economy. Saunders said that unless the MPC “genuinely believes the EMU crisis is about to fade and the U.K. economy is poised to leap into a strong recovery,” it will use the report to signal that the door to further QE “remains open.”

Still, inflation concerns are mounting, with price growth accelerating to 3.5 percent in March, compared with the central bank’s 2 percent goal. Deputy Governor Paul Tucker said April 18 that the “uncomfortably above target” rate could hold above 3 percent into the second half of the year, while minutes of the MPC’s April meeting said there was a risk that inflation may “fall less rapidly” than projected.

“For the moment inflation is the main problem,” said Vicky Redwood, an economist at Capital Economics Ltd. in London. “But more sluggish economic data over next few months should convince the central bank the robust pickup they expect isn’t happening.”

Reports last week indicated manufacturing and services weakened in April after the economy shrank 0.2 percent in the first quarter. Redwood forecasts 50 billion pounds of asset purchases in August and a further 50 billion pounds in November. Peter Dixon, an economist at Commerzbank AG in London, agrees that poor economic growth data and a worsening of the euro-area crisis may spark a fresh round of stimulus.

“The door is still open, without the shadow of a doubt,” he said. “On balance, growth is the bigger problem, and strains in the market could get an awful lot worse before they get better.”

To contact the reporter on this story: Svenja O’Donnell in London at sodonnell@bloomberg.net

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


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