–Impossible To Say When Policy Tightening Will Start
–MPC Watching Domestically Generated Inflation “Extremely Carefully”
–King Defends MPC Policy Inaction So Far And Broad Policy Mix

LONDON (MNI) – The Bank of England’s Monetary Policy Committee is
watching out for any pick-up in domestically generated inflation and
will hike Bank Rate when it is justified, Governor Mervyn King said in
his Mansion House speech Wednesday.

King defended the MPC’s refusal to tighten policy so far and
highlighted some of the weak spots in the UK economy, including soft
money growth and subdued earnings growth. He said it is “simply
impossible” to know when monetary tightening will start.

King acknowledged the sharp differences of view among MPC members
over policy. At recent meeting they have vote for everything from
more quantitative easing to an immediate Bank Rate hike.

The Governor himself gave no indication he would support any policy
change near term. The MPC has set Bank Rate at a record low 0.5% since
March 2009, the longest policy pause since the post war years.

“Of course, at some point, Bank Rate will need to rise to more
normal levels in order to ensure that inflation returns to its 2%
target,” King said.

He said there had been a “lively debate among the members of the
MPC as to when that (policy tightening) point will come.”

He cited what happens to domestically generated inflation and
spreads between Bank Rate and commercial bank lending rates as key
factors in determining the policy path.

“The Committee is watching extremely carefully for any signs of a
pick-up in domestically generated inflation and it will take action as
soon as it is appropriate to do so,” King said.

“Spreads between Bank Rate and the interest rates charged to many
borrowers remain at unprecedentedly high levels, if indeed borrowers are
able to access credit at all. When conditions in the banking sector
return to something closer to normal, those spreads will contract and
the rate at which that takes place will have an important influence on
the speed at which Bank Rate will rise,” King said.

There is disagreement among analysts, and clear uncertainty, over
the likely timing and extent of spread compression, and the BOE has
highlighted the uncertainty surrounding the inflation outlook.

“Uncertainty inevitably surrounds both the speed of the rebalancing
and the impact of today’s consumer price inflation on tomorrow’s
domestically generated inflation. So it is simply impossible to know now
at what point monetary tightening will begin,” King said.

The BOE head defended the MPC from criticism over its refusal to
tighten policy so far, despite inflation increasing to more than double
the 2.0% target and it is expected to rise further.

“We could have raised Bank Rate significantly so that inflation
today would be closer to the target,” King said.

“But that would not have prevented the squeeze on living standards
arising from higher oil and commodity prices and the measures necessary
to reduce our twin deficits. And it would have meant a weaker recovery,
or even further falls in output, despite our having experienced the
worst downturn in output and spending since the Great Depression,” he
added.

King said it made little sense to shift from the current broad
policy mix of tight fiscal policy and loose monetary policy.

“The mix of tight fiscal and loose monetary policy is necessary for
a rebalancing of the economy … Of course, there can always be
differences of judgement about the overall stance of policy, but to
change the broad policy mix would make little sense,” King said.

He said the policy challenge for the MPC came from the combination
of weak growth and high consumer prices.

The BOE head sees continuing signs of economic weakness in the UK.

“So far, subdued rates of increase in average earnings, as well as
remarkably – some might say disturbingly – low growth rates of broad
money have provided strong signals that inflation will fall back in due
course. Banks are still contracting balance sheets and reducing
leverage,” he said.

At the same time “Consumer price inflation has risen to 4.5%, and
further large rises in utility prices are expected. Output has probably
grown by only around 1% or so over the past year.”

Financial Policy Committee Facing Too Weak Lending

In his speech, King also addressed the challenges facing the newly
formed, interim Financial Policy Committee, which meets for the first
time this week.

He said the FPC reflected the fact monetary policy cannot target
both monetary and financial stability.

The current challenge facing the FPC is not the excessive credit
growth seen before the financial crisis.

“The present problem is the reverse – lending is weak. We shall
next week make recommendations in areas where in our judgement risks to
the resilience of the system are increasing,” King said.

The BOE Governor repeated his concerns over the UK’s banking system
being simply too large to be bailed out again.

“Until we find a solution to the ‘too important to fail’ problem,
the size of our banking system will remain too large for the UK taxpayer
credibly to support in future,” he said.

–London Bureau; Tel: +4420 7862 7491; email: drobinson@marketnews.com

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