–BOE Inflation Report Unlikely To Show Case For Monetary Tightening

LONDON (MNI) – The Bank of England’s Monetary Policy Committee may
nudge its inflation forecast higher, without raising its growth
forecast, in this month’s Inflation Report, reflecting concerns the
growth/inflation tradeoff has deteriorated.

The concern at the Bank is that a combination of the credit crunch,
higher commodity prices and sterling’s fall has damaged UK supply
capacity. Unless this capacity is rapidly restored, inflation would turn
out higher than previously predicted even on an unaltered growth
forecast.

MPC member Kate Barker, who leaves the committee at the end of May,
highlighted the Bank’s fears over a deterioration in the
growth/inflation tradeoff in her swansong speech. Inflation has
repeatedly come in above the BOE’s forecasts in recent quarters.

Barker said a rise in commodity prices, or exchange rate fall, both
of which have occurred, can have a long-run impact on supply “by making
some supply uneconomic and bringing about some capital scrapping.”

She said there were grounds for believing “the output gap has
recently not been as large as simple models might suggest, and therefore
higher CPI is less surprising.”

Pricing competition between firms may also have become less
intense, with some participants exiting markets.

Barker said as exchange rate and commodity price effects ease
inflation could fall back “but an alternative and less reassuring
explanation might be that the pricing climate has changed … suggesting
that firms’ prices might respond less for a given degree of slack in the
economy.”

How far the Inflation Report will factor in a worsening in the
growth inflation trade-off is uncertain.

Philip Shaw, economist at Investec, said the MPC could factor it in
by increasing the upside inflation risks, rather than plugging it into
the Report’s central projection.

Even if the central forecast is raised somewhat, its implications
for Monetary Policy are likely to be negligible, Shaw believes.

Based on constant interest rates, in its February Inflation Report
the MPC forecast CPI would fall from 3.33% in Q1 this year to 1.76% in
Q1 2012.

Malcolm Barr, economist at JP Morgan, says in a research note that
while the MPC may make a slight upward revision to its central inflation
projection, two years out inflation was likely to be shown still
undershooting the central banks’ 2.0% target on flat rates.

The BOE’s growth forecast, on the other hand, is highly unlikely to
be raised.

The BOE does not publish a calendar year growth forecast, but
extrapolating from the February quarterly forecasts suggests its modal
forecast is for growth of around 1.4% in 2010 and 3.4% in 2011.

That 2011 forecast is well above those of most independent
forecasts. The Treasury’s latest compilation of independents showed the
average forecast was for 2.1%, with a range of 1.0% to 3.2%.

The latest bout of turmoil in the eurozone will have helped remind
the MPC of the downside risks to the growth forecast. MPC members have
already cited the weakness of the eurozone as a threat, and the latest
developments will have reinforced that view.

After the May Inflation Report is published, at 1030 GMT Tuesday,
BOE Governor Mervyn King will then host the subsequent press conference.

With the UK’s long drawn out 2010 election approaching its
denouement, reporters are sure to try and drag out comments from King on
the fiscal situation. King was alleged to have remarked in a private
conversation that whichever party comes to power will then lose power
for a generation because of the severity of the fiscal squeeze they will
have to impose.

King will probably stick fast to a formulaic response, along the
lines of everyone is agreed on the need to reduce the deficit, and will
seek to avoid becoming embroiled in any political rows.

–London Bureau; Tel: +44207 862 7491 email: drobinson@marketnews.com

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