Bank Chiefs Are Blowing Hot and Cold in Battle over Inflation ; ECONOMIC ANALYSIS [Edition 2]

By Duncan, Hugo | The Evening Standard (London, England), November 24, 2009 | Go to article overview
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Bank Chiefs Are Blowing Hot and Cold in Battle over Inflation ; ECONOMIC ANALYSIS [Edition 2]


Duncan, Hugo, The Evening Standard (London, England)


TEMPERATURES at the Bank of England are rising over how to drive a recovery in the UK economy without sending inflation soaring.

The three-way split on the monetary policy committee over how much extra cash needs to be pumped into the economy caused a stir in the City although, as Bank Governor Mervyn King said today, it was hardly a surprise.

But, as Jonathan Loynes at Capital Economics points out, an even deeper divide has emerged at the heart of Threadneedle Street and it is over asset prices. This reflects a debate going on at central banks around the world over how much attention should be given to the price of assets such as houses in setting monetary policy.

Minutes from this month's MPC meeting showed Spencer Dale, the chief economist at the Bank, opposed the decision to extend quantitative easing from Pounds 175 billion to Pounds 200 billion on these very grounds. He argued that there was a risk "that further substantial injections of liquidity might result in unwarranted increases in some asset prices that could prove costly to rectify, complicating the task of meeting the inflation target in future".

Dale seems at odds with King. At the inflation report just six days after the MPC meeting ended, andf again today, King said that it would be "peculiar" to worry about asset prices at the moment, even though the FTSE 100 index is up 50% since March and house prices between 5% and 10% this year.

King said: "The increase in asset prices that we've seen, particularly in the last eight or nine months, are in part I think a reflection of the fact that a possibility of a real disaster has sharply diminished.

The actions that have been taken around the world have very sharply diminished the prospect of something like the Great Depression. That in itself was bound to remove some of the tail risk that would have led to asset prices having fallen so much, and lead to a rebound of asset prices. That's to be welcomed, not to worry about it.

"And it's still the case, if you look at asset prices, they're well below the levels that they reached in the peak. So it's not as if people have re-inflated some bubble based on a rapid expansion of credit that appears unsustainable."

King went on to say that it was "pretty obvious" that if interest rates stayed at 0.5% and it carried on printing money "indefinitely" then "we would see not only asset prices rise to levels that would concern us, but also inflation would rise to a level that would worry us".

So, like Dale, King has an eye on asset prices. He just does not think they are a problem yet.

The Governor won the day at this month's meeting but if other members of the MPC start to take Dale's view, the stimulus to the economy the Bank has provided through record low interest rates and quantitative easing could start to be withdrawn sooner than expected.

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