Bank faces tricky call on monetary policy

By David Milliken

LONDON (Reuters) - The Bank of England faces a tricky call in deciding how to tighten monetary policy as the economy recovers, and would not rush into hefty gilt sales, Deputy Governor Charles Bean said on Thursday.

Even if the low-point in economic activity was not far off, the strength of any economic recovery was uncertain and likely to be relatively low, Bean said in a speech to manufacturers in Sheffield.

Tightening monetary policy is not on the Bank's current agenda, as only two weeks ago its Monetary Policy Committee unanimously approved a further 50 billion pounds in asset purchases to boost the economy.

But Bean is the first policymaker to discuss in depth the options for tackling future inflation risks, and said the Bank did not have to sell back what could amount to 125 billion pounds of asset purchases before raising rates.

"We presently have only the asset purchase programme as a tool to stimulate demand. But when it comes to tightening policy, we have two instruments at our disposal: asset sales; and raising Bank Rate. It is not necessary to unwind the asset purchases before raising Bank Rate," Bean said.

"If we felt the need to drain the extra reserves from the system rapidly, we could also do it by exchanging the reserves for short-term Bank of England bills, allowing us to stagger the sales of the gilts," he continued.

So far the Bank has bought around 64 billion pounds of gilts, providing valuable support for the assets at a time when the government plans to issue a record volume of debt to fund a budget deficit that analysts to not expect to shrink much over the next few years.

If the Bank were to sell gilts en masse, this could easily depress prices and push up the effective interest rate paid by the government for its new borrowing.