Will MPC Gamble Its Last Pounds 25bn to Boost Economy? the Bank of England Looks Likely to Keep Interest Rates at 0.5% This Week, but Faces a Difficult Decision over Its Quantitative Easing Programme, Writes Economist Howard Archer

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Byline: Howard Archer

THE likely outcome of the two-day meeting of the Bank of England's Monetary Policy Committee (MPC), which begins today, is extremely easy to call on one hand and very difficult to call on the other.

The easy call is that the MPC will keep interest rates at their record low level of 0.5%. Indeed, we strongly suspect that interest rates will stay down at 0.5% deep into 2010.

The difficult call is what will the MPC decide to do on quantitative easing (QE)? We lean towards the view that the MPC will choose to use the final pounds 25bn that it is authorised to spend by Chancellor Alistair Darling, taking the amount up to pounds 150bn, but to indicate that it is not looking to spend any more than this for now at least.

However, we expect the MPC to indicate that it will continue to monitor the situation very closely and not to shut the door on further QE in the future.

The minutes of the July meeting of the Bank of England's Monetary Policy Committee (MPC) revealed that all nine committee members voted in favour of holding interest rates at 0.5% and not increasing the total of pounds 125bn being spent on the purchase of assets under the QE programme.

The minutes indicated that the MPC felt there was no pressing need to extend the QE programme in July, but preferred to review the situation at the August meeting when committee members would have access to the Bank of England's new inflation and GDP forecasts.

This is not unusual as the MPC has historically been more prone to make policy adjustments during the months when the new Bank of England projections are available.

This would also give the committee another month to monitor what impact the QE enacted so far is having, although MPC members have repeatedly stressed in recent speeches and interviews that it is premature to come to any conclusion on this as it will take several months for the effects to work through.

UK recovery hopes have recently taken a significant knock, with the news that GDP contracted by a further 0.8% quarter-on-quarter in the second quarter.

While this was down markedly from a contraction of 2.4% quarter-on-quarter in the first quarter, and 1.8% quarter-onquarter in the fourth quarter of 2008, it was still a substantial drop and suggests that recovery hopes are based on a rockier base than had been previously thought.

Indeed, it was a markedly worse performance than the MPC had expected as the minutes of their July meeting had observed that latest surveys "were consistent with a smaller contraction in GDP in quarter two than the MPC had anticipated two months ago" (when the Bank of England's last GDP and inflation forecasts were done) and that "the momentum going into the second half of the year was greater than the Committee had expected in May".

In fact, a second quarter contraction of 0.8% quarter-onquarter and earlier downward revisions to the national accounts data mean that GDP was down by 5.6% year-on-year in the second quarter, rather than by 4.7% as the Bank of England projected in May.

While the latest data and survey evidence has been firmer overall, this is by no means universal and significant uncertainty remains on the strength of economic activity over both the near term and further out.

On the positive side, retail sales rose by a healthy 1. …