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Economic Update – Forget rate rises, more QE will be the next policy change

Roger Bootle’s response to July’s MPC meeting


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  • With the economic recovery still showing few signs of regaining momentum, the case for raising interest rates is looking extremely weak. With the economy in for a prolonged period of softness and inflation set to fall sharply next year, I think that renewed quantitative easing is far more likely than an interest rate rise.
  • It looks as though the economy in the second quarter struggled to expand by much more than 0.3% or so – less than half its trend rate.
  • Admittedly, this may be partly down to temporary factors – including the disruption to supply chains after the Japanese earthquake and April’s extra bank holiday.
  • However, I have not detected any recent improvement. The CIPS/Markit business surveys remained weak in May and June. Consumer confidence dipped in June. The housing market is still treading water. And high street giants seem to be falling left, right and centre.
  • What’s more, the economy faces further challenges. Much of the recent weakness reflects the effects of past rises in commodity prices, meaning that the fiscal squeeze is yet to have its full effect.
  • And events in Greece continue to cast a shadow over the economic outlook here. Admittedly, the risk of an imminent Greek disaster appears to have eased. And the UK’s direct exposures to Greece are not huge.
  • However, I do not see how Greece can ultimately get out of this mess without both defaulting and leaving the euro. And the biggest risk to the UK lies in the exposure of European banks to Greek debt and in the knock-on effects of a European banking crisis on the European economy.
  • At least the UK has so far escaped contagion fears. But to the extent that this reflects the fact that the Government has a credible fiscal plan, this just increases the pressure on the coalition to stick with its Plan A.
  • Of course, the MPC cannot simply neglect the inflation situation. And the fact that inflation expectations rose sharply in June would seem to lend support to those on the Committee arguing that this period of high inflation is damaging the MPC’s inflation-fighting credentials.
  • But there is no evidence that the rise in inflation expectations is feeding through into pay growth, with pay settlements holding steady in the past few months. And I think that inflation expectations will fall back once inflation itself drops next year. I therefore still think that raising interest rates now would achieve nothing positive.
  • Meanwhile, June’s MPC minutes showed that the possibility of further quantitative easing (QE) has started to attract more attention. Undertaking further asset purchases has both pros and cons. But given that the MPC has little other option, I think that more QE is likely if the recovery remains as weak as I expect.
  • Admittedly, the Committee’s unlikely to go down this road while inflation is still so high, and rising. However, my money’s on QE2 in 2012.

Roger Bootle, Economic Adviser to Deloitte (Tel: 020 7823 5000)

This assessment contains general information only and is not intended to be comprehensive nor to provide professional advice.  It is not a substitute for such professional advice and should not be acted on or relied upon or used as a basis for any decision or action that may affect you or your business.  Deloitte LLP accepts no duty of care or liability for any loss occasioned to any person acting or refraining from acting as a result of any material in this assessment.

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