MPC holds fire as double dip fears recede

Economics Editor,Sean O'Grady
Friday 05 November 2010 01:00
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Stronger than expected signs of sustained recovery prevented the Bank of England from a launching a second round of "quantitative easing", the direct injection of money into the economy, leaving economists speculating that the Bank's next move may be to raise rates, although only modestly and in many months' time.

As fears of a "double dip" recede, so the Bank feels less need to push more money into the economy to support economic activity and ensure that the inflation target of 2 per cent is not undershot badly over the next two years. At least one member of the Monetary Policy Committee (MPC), the external appointee Adam Posen, had spoken forcibly in favour of more QE in recent weeks, and the Governor, Mervyn King, has also spoken publicly about the worrying lack of growth in the money supply.

On the other end of the spectrum there seems little reason to doubt that the MPC's current "hawk", Andrew Sentance, will have changed his mind. Thus, when the MPC minutes are published in 10 days it seems likely they will display a second successive month where opinion on the committee was split three ways.

The European Central Bank, also inline with expectations, decided to keep its monetary policy on hold too, with official rates at 1 per cent for the 18th successive month. In refusing to follow the Fed's lead both the Bank of England and the European Central Bank will be aware that they will be making life more difficult for their exporters, as the dollar slides ever lower under the weight of $600bn in new money.

However, there was speculation in Frankfurt that the ECB has intervened to buy Irish government securities in recent weeks, as confidence in the Dublin government's ability to deliver a successful austerity programme has weakened; its borrowing this year will reach 31.9 per cent of GDP, against 10.1 per cent in the UK, itself one of the larger shortfalls among the advanced economies.

Although there is still a realistic possibility that the Bank of England will boost QE, probably at its February meeting, some economists believe that the Bank's next move will be to tighten policy. George Buckley, chief economist at Deutsche Bank, said: "We remain of the opinion that there will be no double dip.

"As a result, we do not forecast a second round of QE but rather see the next move in policy being higher rates in the middle of next year, just ahead of the ECB and Federal Reserve. The name of the game will be gradualism, however – households have a lot of debt, the repayments on which are highly sensitive to changes in short rates."

The Bank's latest Inflation Report, its definitive view of the economy, is published next Wednesday.

QE has the desired effect: How the markets responded

Equities

The US market was almost unmoved immediately after the Fed announcement, but joined the party today. The Dow Jones index went to a two-year high, while the FTSE 100 is almost back at pre-recession levels – two-thirds better than its nadir last March. Germany's DAX climbed 1.2 per cent, China's Shanghai Composite 1.9 per cent and Japan's Nikkei gained 2.2 per cent, despite pressure on their exporters.

The dollar

Down 5 per cent on a trade-weighted basis over a few weeks. This will help America's huge trade deficit. US Treasuries went higher; yields on five-year, index-linked paper went negative.

Sterling and the euro

Sterling rose to a nine-month high against the dollar and the euro bounced by 1 per cent, further reversing the losses during the sovereign debt crises. The president of the European Central Bank, Jean-Claude Trichet, gave little away after the ECB move, saying he had "no indication" that the US wants the dollar to slide.

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