BoE policy on hold for now as UK economy worsens

 

By David Milliken LONDON | Thu Aug 2, 2012 11:24am EDT (Reuters) - The Bank of England decided it was too soon on Thursday to step up efforts to bolster Britain's recession-hit economy, although future action looks increasingly likely as growth shows little sign of rebounding after a dismal few months. Britain's economy tipped into its second recession in four years at the end of 2011, and a multi-year austerity program to close the country's vast budget deficit is weighing both on consumer morale and the government's popularity. The BoE restarted its asset purchase program, which aims to lower big companies' capital costs, last month, and Wednesday marked the start of a joint scheme with the finance ministry to reduce the cost of bank loans for home-buyers and businesses. As a result, almost all economists polled by Reuters had expected the BoE to make no change on Thursday to its plan to buy 50 billion pounds of British government bonds, which will take total purchases to 375 billion pounds by early November. Interest rates likewise stayed at a record low 0.5 percent. But if economic data continues to disappoint in the way it has in recent weeks, the central bank may not have the luxury of waiting long before deciding on its next policy move. "While the unchanged decision isn't a surprise there is a question mark as to whether current policy settings are appropriate," said David Tinsley, UK economist at BNP Paribas. "It is probably not the sort of macroeconomic environment where policymakers want to be doing too little." European Central Bank President Mario Draghi discovered the danger of disappointing market expectations on Thursday when he said the ECB was merely considering - rather than immediately implementing - a new program to buy euro zone debt. Stocks and the euro fell and Spanish and Italian bond yields rose after the ECB's monthly meeting brought no bold new moves, partially reversing a rally in riskier assets since Draghi surprised markets last week with a pledge to save the euro. British economic output shrank by 0.7 percent in the second quarter, a much bigger fall than economists had expected, even taking into account the effect of an extra public holiday and months of unusually wet weather. Both the BoE and Britain's coalition government blame the euro zone crisis for the fact that Britain has been in recession since late 2011. But Germany and France, which are at least as heavily exposed to the debt troubles on the euro currency bloc's periphery, have seen stronger growth over the same period. Moreover, there is little sign so far of a hoped-for rebound in the third quarter from London's hosting of the Olympics. Manufacturing activity fell at its fastest pace in more than three years in July, according to a survey of purchasing managers, and while construction improved, builders warned of disruption to deliveries from the Games. The one bright spot is strong job creation since the start of the year, which has pushed unemployment down to 8.1 percent. FURTHER STIMULUS SEEN Most economists polled by Reuters before Thursday's decision expect further asset purchases with freshly created money, also known as quantitative easing, later this year. The BoE might even lower interest rates again - something it has steadfastly resisted since its last rate cut in March 2009. At July's meeting, MPC members said they may reconsider a rate cut in a few months time, once they have assessed the impact of the new Funding for Lending Scheme that offers cheap financing to banks which lend to businesses and home-buyers. A clearer insight into the central bank's outlook will come on August 8, when BoE Governor Mervyn King presents the central bank's quarterly forecast update. "King will stress - as he has for the past year - the damage from the euro zone crisis and the impact of that on the growth and inflation forecasts," said Brian Hilliard, an economist at Societe Generale. As well as weak growth, inflation has fallen much faster than the BoE predicted in May to hit a 2-1/2 year low of 2.4 percent in June - close to the central bank's 2 percent target - and some economists now fear it may substantially undershoot. "It would be a surprise if the (BoE) were expecting an inflation rate in two years time that was close to their target. More likely it will fall short by some margin. That would imply there was 'room' for more monetary easing," said BNP's Tinsley. Further easing would be welcomed by finance minister George Osborne, who lost a reputation for political sure-footedness after a Budget that seemed to fund tax cuts for the very rich with higher taxes for pensioners and poorer Britons. Last month the International Monetary Fund said Osborne may need to reconsider how to reduce Britain's budget deficit - the centerpiece of the coalition government's policy program - if BoE and other measures do not boost growth by early next year. But for now, the focus remains on the central bank. (Additional reporting by Sven Egenter and Olesya Dmitracova; Editing by Catherine Evans)

 

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