David Prosser: Have MPC members lost their nerve?

Friday 07 August 2009 00:00

Outlook It's been a good few weeks since the Chancellor and the Governor of the Bank of England last contradicted each other in public, but don't bet on the ceasefire holding. Alistair Darling certainly has every reason to be nervous about next week's Inflation Report from the Bank, if yesterday's moves on quantitative easing from the Monetary Policy Committee are anything to go by.

Mervyn King has already produced one set of economic forecasts that were markedly less optimistic than Mr Darling's prognosis for the future, predicting in May's Inflation Report that the UK would not move into recovery phase before next year. Judging by the MPC's statement yesterday, its members are no less gloomy three months on.

There was a moment last October when the MPC suddenly seemed to get the scale of the impending recession. The committee's shock 1.5 percentage point interest-rate cut was a sudden and frank admission that it had been too slow to react to the slowdown and that drastic action was necessary. Yesterday's extension of QE wasn't quite at that level of surprise factor, but the change of tone from the MPC was something of a bolt from the blue. Only a month ago, the committee was content to hold off deploying the final £25bn of the QE budget it had already been granted.

What's interesting is that not a great deal has changed since July's MPC meeting. We've had a poor set of second-quarter GDP figures but while a contraction of 0.8 per cent was disappointing, only the sunniest of analysts had been expecting much better news. We've also had money supply figures, which seem to show the Bank's previous QE purchases have had only a limited effect, but there are plausible explanations for why this may only be a temporary issue.

On the other hand, some of the economic data published between the July and August meetings has been much more positive. This week's numbers for services, manufacturing and construction have all been hopeful, for example. House prices seem at last to have turned the corner. Suddenly, though, the MPC seems minded to accentuate the negative – in particular, the fact that lending to business continues to decline. It may be that those money supply figures have spooked the committee, but its members seem to have lost their nerve, even while noting that business and consumer confidence finally seems to be improving.

Clearly, the committee thinks it does not have a great deal to lose – at least in terms of its inflation target – by extending QE. You can expect the Inflation Report on Wednesday to show lower projections for price rises than last time. It is the growth projections, however, that will worry Mr Darling, undermining as they will his expectations for the public finances. The scene is set for the latest round in his public sparring with Mr King.

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