Economic Update - Economy needs more support nowRoger Bootle’s response to September’s MPC meeting |
- With the news on the economy deteriorating rapidly and financial markets now in a state of panic, the need for additional policy stimulus is becoming urgent. While the MPC has held back from sanctioning additional quantitative easing today, I think that the economy needs additional support immediately.
- The pronounced weakness of the recent economic data has pretty much wiped out any prospect of a near-term hike in interest rates. Indeed, the weighted activity index of the CIPS/Markit surveys is now consistent on the basis of its past relationship with quarterly contractions in GDP of about 0.2%. The index is also at a level which has typically seen the MPC cut interest rates in the past.
- What’s more, the CIPS/Markit surveys excludes the retail sector, which – if the weakness of consumer confidence is taken at face value – looks set to enter a renewed downturn over the coming months too.
- Indeed, markets now expect official rates to remain on hold for at least another two years.
- The key question now is whether policymakers are bold enough to restart QE. Unfortunately, inflation is still likely to climb over the next few months - by my reckoning, CPI inflation could peak at 5% or more towards the end of this year, before falling sharply in 2012.
- This might be just enough to prevent the MPC from sanctioning QE this year. Note that, back in 2009 when QE was first sanctioned, inflation had already fallen sharply from its peak in 2008 and core inflation was well below 2%. Some members of the MPC may be reluctant to sanction more QE until there are visible signs that inflation is falling, given the potential risk that further QE boosts assets prices (such as commodity prices) and pushes up inflation expectations.
- But they would be wrong to wait – as I have long argued, deflation rather than high inflation is the bigger medium-term threat. And the economy needs as much support as it can get right now. Granted, more QE is unlikely to be a panacea for the ills that the economy is currently suffering from. But it is virtually the only tool that policymakers have left. They should not delay in restarting the policy.
Roger Bootle, Economic Adviser to Deloitte (Tel: 020 7823 5000)
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