LONDON (MNI) – The UK economy contracted in the fourth quarter of
last year but survey evidence suggests it is now expanding again and
domestically generated inflation should stay subdued, Bank of England
Deputy Governor Charles Bean says in a speech Thursday.
Bean sets out the thinking behind the BOE Monetary Policy
Committee’s decision to sanction the latest wave of quantitative easing,
saying February’s Stg50 billion tranche was justfied by the likelihood
of inflation undershooting the target without it.
While seeing some encouraging signs in the domestic economy, he
warns that the risk of disorderly euro area developments remain.
Analysts expect Bean to have backed the QE increase at the Feb 8
and 9 MPC meeting and his speech, to the Scottish Council for
Development and Industry, does nothing to contradict this view. The
minutes of the February meeting will be published Wednesday.
“In the absence of the extra stg50 billion of gilt purchases
announced two weeks ago, we judged that inflation would be rather more
likely than not to undershoot our 2% target in the medium term. That was
why we decided that it was necessary to do more,” Bean says.
Bean noted that CPI has fallen sharply, from its peak of 5.2% to
3.6% in January and with the margin of spare capacity set to persist
“domestically generated inflation – presently running around 1.5%,
depending on exactly how one chooses to measure it – should stay
subdued.”
BOE’s Bean discussed the background to the MPC’s decision to
relaunch a second wave of QE back in October. There was the deceleration
in growth as 2011 wore on, with real household incomes falling and the
onset of the euro area crisis. The latest data, however, had been
upbeat.
While UK GDP contracted in late 2011 “some of the business surveys
at the start of this year suggest that the economy may again be
expanding,” he says.
“Despite the recent more encouraging signs, we continue to expect
underlying growth to remain sluggish in the first half of the year (the
actual data are likely to move somewhat erratically because of the extra
holiday associated with the Queen’s Diamond Jubilee),” Bean says.
With headline inflation falling, the squeeze on real household
incomes is easing and that “should facilitate a modest pickup in
household spending; the upbeat retail sales figures announced at the end
of last week may be a sign this is already starting to happen,” he says.
The retail sales data showed a 0.9% monthly rise in volumes in
January and January activity surveys were robust, but Bean cautions
against expecting a strong recovery.
“While growth should gradually strengthen, the continuing headwinds
from the unwinding of excessive debt and the Government’s continuing
fiscal consolidation mean that the pace of recovery is likely to remain
moderate by historical standards,” he says.
The big threat to this picture of a moderate domestic recovery, and
subdued inflation, comes from the euro area, with the Greek bail-out
deal not eliminating the risks from the single currency zone.
“While this morning’s agreement between the Greek government and
the euro-area authorities is certainly welcome, there still remains a
possibility that events could unfold in a disorderly and damaging
fashion at some stage in the future,” he says.
Bean lists the ways in which euro area disorder would impact on the
UK, by hitting exports, by hitting UK bank funding and thus domestic
credit, and by knocking business and consumer confidence.
He defends the MPC’s decision not to factor in the extreme downside
risks from the euro area into its policy decisions, and they are not
included in the Inflation Report’s central projections as the MPC
believes they are unquantifiable.
“There is little that the Monetary Policy Committee – or, indeed,
the Government – can do to influence the outcome of events beyond our
shores. In particular, it would make little sense to set the level of
asset purchases so as to try to counteract an extreme event whose
likelihood, timing and magnitude we have no realistic way of assessing,”
he says.
–Bean Defends QE From Charge It Hits Pensioners, Savers
In the final part of his speech, Bean takes on the critics who have
been arguing against QE on the grounds it is ineffective or hits savers
and pensioners hard.
On its effectiveness, the BOE’s in-house research found the first
wave of QE had a substantial impact on both growth and inflation, at
peak adding 1.5 percentage points to the level of GDP and 1.25pp to
inflation.
“Tracking the impact of the new round of purchases is harder than
before,” with market participants pre-empting the MPC’s QE decisions,
making it harder to strip out their effects, Bean says.
But there is no clear evidence the impact of QE2 will be much
different from QE1.
“So far we have seen little to suggest that the effect on nominal
demand will be markedly at odds with that of our first round of
purchases. But it is still rather early to draw firm conclusions one way
or the other,” he says.
Pension and pensioner lobby groups have led the way in criticising
the impact on QE, as it drives down yields, pushing down rates of return
for pensioners.
The BOE takes the view this is only a partial analysis of QE’s
impact. QE also pushes up the value of gilts and other assets, boosting
the pension pot.
“The rise in asset prices as a result of quantitative easing
consequently also raises the value of the pension pot, providing an
offset to the fall in annuity rates. The impact of quantitative easing
on those approaching retirement is thus more complex than it seems at
first blush,” Bean says.
The broader economic picture also dictatates that monetary policy
should be loose, and setting policy tighter to protect savers would have
hit activity, employment and even hampered fiscal consolidation.
“If we had chosen to run a substantially tighter monetary policy,
then that would only have served to depress activity and raise
unemployment even further. By slowing growth, it would also make the
task of fiscal consolidation and deleveraging even more challenging,”
Bean says.
–London bureau: +4420 7862 7491; email: drobinson@marketnews.com
[TOPICS: MT$$$$,M$$BE$]