The Emerging Split on the Bank of England’s MPC

Posted on 29/09/2010


The Bank of England’s Monetary Policy Committee (“MPC”) has maintained interest rates at current 0.5% level since March 2009 and its Asset Purchase Programme (a.k.a. quantitative easing) at £200bn since November 2009, the consensus amongst the committee members is now beginning to break down, creating uncertainty regarding the future direction of monetary policy.  One member of the committee, Andrew Sentance, has voted in favour of a 25bps rate hike since June 2010.  He put across his arguments in a recent interview with the Nottingham Post:

There is no need [to restart QE] in my view.  I actually think we should be preparing the ground for gradually increasing interest rates in a measured way to reflect the fact that the economy has improved and the inflation situation is not where we would like it to be.  I see QE and very low interest rates as the response to the very difficult situation which we faced from autumn 2008 to the middle of last year.  As the economy improves, and particularly when inflation is above target, we should be gradually moving back to a more normal level of interest rates.

However, Sentance’s views are not shared by all the members of the committee.  Adam Posen, while not yet having voted for an expansion of the Bank of England’s quantitative easing policy, made some strong statements in favour of such an expansion in a recent speech given to the Hull and Humber Chamber of Commerce, Industry and Shipping:

In every major country, actual output has fallen so much versus where trend growth would have put us, and trend growth has not been above potential for long enough as yet, that there remains a significant gap between what the economy could be producing at full employment and it currently produces. Thus, policymakers should not settle for weak growth out of misplaced fear of inflation. If price stability is at risk over the medium-term, meaning over the two- to three-year time-horizon for the MPC’s decisions, it is on the downside.  The risks that I believe we face now are the far more serious ones of sustained low growth turning into a self-fulfilling prophecy, and/or inducing a political reaction that could undermine our long-run stability and prosperity.  Inaction by central banks could ratify decisions both by businesses to lastingly shrink the economy’s productive capacity, and by investors to avoid risk and prefer cash.  Speaking for myself, I believe that if we were to loosen monetary policy further, it must primarily take the form of large scale asset purchases.

In summary, we have two eminent (Phd) economists reading the same data and analysis regarding the economy and coming to two starkly different conclusions, with one stating that the economy is now normalising and the other of the view that the UK risks a period of sustained low-growth, “almost precisely tracing the track of Japan post-1993”.  This should serve as a warning to investors, and especially to politicians, who have pre-conceived forecasts of how the economic recovery (or lack thereof) will play-out.  The most important lesson I take from this is to take no strong investment position (in either direction) with respect to the UK economy and that I should continue to carefully analyse new data releases.

Posted in: Economy