Bank of England's QE policy hinders growth, warns report
The Bank of England’s Monetary Policy Committee (MPC) will consider a further injection of funds into the economy through quantitative easing (QE) when it meets for its monthly rate-setting meeting on Thursday.
However a report by Fathom Consulting contends that the bank's QE policy could be influencing the lack of growth in the economy because QE causes a lack of competition between companies to supply goods and services rather than affecting demand from customers.
Fathom say that the bank's relaxed stance on monetary policy - combining low interest rates with QE - fuels inflation and contributes towards a phenomenon known as "negative supply shock". This was a feature of the recession in the 1970's.
With the MPC meeting this week, analysts had expected to see a possible further extension of the QE policy in May, following the last move when £50 billion of funds was injected into the economy taking the total of QE up to £325 billion.
However, last month saw a surprise increase in the consumer prices index (CPI) measure of inflation, up from 3.5 per cent to 3.6 per cent, the first rise for six months.
Danny Gabay, director at Fathom, believes the current spike in inflation has been influenced by the bank's policies. He said: “The UK is suffering from a combination of anaemic growth and excessive price inflation. It is displaying all the classic hallmarks of a negative supply shock. If so, the current stance of monetary policy is set to the wrong dial. Just as in the 1970s, it may be exacerbating rather than alleviating the problem.
“The right response to a negative supply shock is a modest tightening of real interest rates.”
The rise in inflation has lessened the likelihood that the bank will use QE again as QE is seen as a factor influencing a rise in inflation. The current inflation trend has made the decision that the MPC makes more finely balanced.
So, although rising inflation may put the MPC off the idea of more QE, the dire state of the economy and the lack of growth will push them to consider trying once again to stimulate growth by more QE.
Howard Archer, Chief UK & European Economist at HIS Global said: “It is an extremely tight call as to whether or not the MPC will go for more Quantitative Easing at the conclusion of their May policy meeting on Thursday.
“The MPC’s dilemma is a result of an unpalatable mix of sticky elevated inflation and weakened economic activity.
“We lean towards the view that the Bank of England will hold off from announcing more QE on Thursday.”
The Bank of England and many economists believe the picture of the UK economy is not as bad as made out from recent data and survey evidence and despite the fact that the UK has now entered a double-dip recession. The consensus is that there is more underlying economic growth than official data shows.
This week also sees economic releases for industrial production and retail sales before Thursday’s meeting.
Following the disappointing results for the Conservative party in last week’s local elections, it is possible that the tory leadership could announce some new economic stimulus, though the Chancellor, George Osborne shows no sign of abandoning his austerity measures.
The long-awaited announcement on banking reform following the Independent Commission on Banking headed by Sir John Vickers should see the split between retail and investment banking entered into the statute books this week in the Queen’s speech on Wednesday.
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