Fears of new asset bubbles split the Bank

Signs of life in the real economy but divisions on QE
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The Independent Online

The Bank of England's Monetary Policy Committee is split three ways on the risks to the economy of further inflation, or deflation, according the minutes of their last meeting.

While at their 5 November session seven members of the Committee, including the Governor, Mervyn King, voted for the agreed £25bn increase in the quantitative easing programme to £200bn, one member, the Bank's chief economist Spencer Dale argued for no change. One other, the external and independent economist David Miles, urged a larger rise, of £40bn.

The exposure of differences over how much more money needs to be injected into the economy to boost spending came as fresh surveys from the Bank's network of regional agents and the CBI suggest that the economy is showing modest signs of growth.

The MPC discussed the case for cutting the interest rate that the Bank of England pays on the reserves the commercial banks hold with it, though recommended no change for now. The Bank Rate was kept at 0.5 per cent. Last week Mr King said that the MPC would keep an "open mind" on changes to QE.

The minutes suggest that the drop in British GDP in the third quarter of 0.4 per cent was as much a shock to the Bank as to the rest of the nation, and added to the uncertainty over the future path of the economy and of inflation. This has been a feature of the Bank's proceedings for some months.

Last week the Bank was criticised by some City economists for allegedly "confusing" signals in the presentation of the Inflation Report, where the Governor's rhetoric was gloomier than the forecasts themselves.

It is the chief economist's attitude that has focused attention now. Mr Dale has spoken in the past about his fears that QE may simply be feeding new, unspecified, "asset bubbles", though one aim of the policy has been to raise asset prices and stimulate capital markets so that companies can raise fresh capital from rights issues and corporate bonds, to replace bank lending.

Mr Dale repeated these concerns at the MPC meeting. The minutes noted: "A risk that further substantial injections of liquidity might result in unwarranted increases in some asset prices that could prove costly to rectify, complicating the task of meeting the inflation target in future."

Next year the inflation outlook seems especially volatile; inflation will, according the Bank's own forecast exceed 3 per cent as a result of rises in VAT, the 25 per cent depreciation in the pound over the last two years and new spikes in commodity prices, especially oil. Prices have gone form below $40 a barrel earlier this year to close to $80 now.

Other commodities, from copper and tea to cocoa and gold have also shown marked rises this year. The resurgence of growth in China and other fast emerging economies promises to push them still higher.

Should inflation remain well above the Bank's official 2 per cent target for long periods next year the danger is that inflationary expectations could become "unanchored", with potentially disastrous consequences – the return of stagflation. The spike in CPI from 1.1 per cent in September to 1.5 per cent last month adds to fears that inflation may soon prove a problem – even when there is much excess capacity.

Meanwhile in the "real" economy the bank's agents report improving consumer spending and exports, and suggest that availability of credit may have "eased slightly". The CBI said that after a dip in October, the improvement in orders takes the reading to its highest since December 2008. It also said export activity had picked up.