Published: Tue, 10 Feb 2009 14:54:18 +0100

UK Preview: Further Clues on Policy to be Revealed in BOE Inflation Report

According to Barclays fixed income strategist Moyeen Islam, the Bank of England's "relatively neutral" statement accompanying a 50 bps rate cut to 1.00% last week means the central bank is considering a pause in the interest rate cutting cycle.

"We expect the Inflation Report to highlight the substantial downside risks to the economy and to justify policy rates being on hold for longer than the market currently has priced in," he said.

Indeed, a key point of focus last week was the central bank's acknowledgment that, "the past cuts in Bank Rate would in due course nevertheless have a significant impact."

However, Howard Archer at IHS Global Insight said the report is likely to include sharp downward revisions to growth and inflation forecasts, suggesting that the recession in the UK will be "both deeper and longer" than the central bank previously expected.

As a consequence, Archer said the Bank of England is likely to continue fostering expectations of more rate cuts in the pipeline for the central bank.

Some economists, including those at High Frequency Economics, believe the report will project prices falling so sharply that "zero interest rates are coming very soon."

Alternative monetary policies will also be in focus after the Bank of England announced a deal with the Government whereby the central bank would buy up to £50 billion in assets through the Asset Purchase Facility (APF).

Nevertheless, economists are quick to point out that since the program is funded by the government, it does not constitute "quantitative easing" whereby the central bank uses its balance sheet to purchase toxic assets by printing new money.

"What we hope to see in the report is an extensive discussion of the use of the new Asset Purchase Facility (APF) and the possible move to Quantitative Easing," said Brian Hilliard at Societe Generale.

The wording of the BOE's statement accompanying the decision to cut rates was significant in that the BOE attributes the APF as a government rather than central bank initiative, he added.

A research note from Morgan Stanley suggests quantitative easing will be the central bank's only recourse down the road, since lower rates are not being passed on to consumers.

The BOE is running out of "ammunition" to fight the financial crisis, the Morgan Stanley economists write, adding that they hope to receive some signals on "how soon the MPC would consider 'unconventional measures'."

Morgan Stanley also thinks rates in the UK have bottomed.

By Erik Kevin Franco, efranco@economicnews.ca, edited by Stephen Huebl, shuebl@economicnews.ca

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