LONDON (Reuters) - The Bank of England risks seeming out of touch to recession-hit Britons next month if - as still seems likely - it calls a halt to its 325 billion pound programme of monetary stimulus.
The central bank seems to believe that a raft of upbeat private-sector surveys offer a better guide to the growth than Britain’s official data. However, it may take an uncomfortable six months before it knows whether its hunch was right, or it stopped helping the economy at just the wrong time.
Britain’s economy shrank more than 7 percent during its 2008-09 recession, and had only partly recovered when the Office for National Statistics’ numbers showed that it had slid back into recession, contracting 0.2 percent in the first three months of this year.
This inflamed the political debate about the austerity plans that form the raison d‘etre of Britain’s coalition government, with Labour Party leader Ed Miliband accusing Prime Minister David Cameron of “arrogance and complacency”.
But the BoE, which usually stays above the political fray, may soon face similar accusations. Moreover, the BoE’s determination to look through weak growth data due to one-off effects echoes the controversial approach it has taken to inflation, where it has played down a series of price spikes.
“I think they have boxed themselves into a corner,” said David Page, UK economist at Lloyds. “The committee was keen to take a break from QE, but I‘m not sure latest GDP data gives them that luxury.”
In the minutes to its April Monetary Policy Committee meeting, published last week, the BoE said it “was minded not to place much weight” on weak official construction data that risked causing another quarter of falling GDP.
Instead it said a wide range of business surveys pointed to moderate underlying growth in the first half of 2012, and that inflation - which had just risen for the first time in six months - risked remaining above target for longer than expected.
BoE deputy governor Paul Tucker went further in a rare speech on monetary policy the same day. “Mismeasurement” was a possible factor behind the weak construction data, and he said Britain’s “growth outlook still looks broadly on track, but it is not always going to seem like that ... as the ONS data for the first half of the year are published.”
Taking the minutes and Tucker’s comments together, financial markets reduced bets on further quantitative easing in May when the 50 billion pounds of gilt purchases approved in February are complete. Wednesday’s GDP data did not cause a big reappraisal.
“We suspect they won’t provide more QE because of what they were saying in April, but it is a tough call,” said Page.
Monetary policy - whether it is changing interest rates, or buying government bonds with newly created money - takes months if not years to have its full effect, and so inevitably involves looking beyond short-term volatility.
In recent years, the BoE has looked past a series of shocks which sent inflation well above its 2 percent target when deciding to conduct QE, due to worries about growth weakness and the medium-term downward effect of this on inflation.
MPC member Adam Posen - hitherto a big supporter of QE - said last week that the committee was now prepared to do the same with the ONS growth data.
“My own personal view is that I think the economy is stronger than what that data is going to show,” he said. “There’s a truth that’s different from the numerical reality.”
The tricky bit, he acknowledged, would be persuading the public to believe that. The BoE already sees a risk that GDP will fall in the second quarter due to an extra public holiday, so it could be late October before third-quarter data appears, confirming Britain is out of recession.
And convincing the public is about more than avoiding unflattering newspaper headlines. April’s minutes explicitly identified the risk of Britain’s entry into recession triggering a vicious cycle of falling business and consumer confidence, turning a temporary dip into a more lasting downturn.
Posen said he was encouraged by the BoE’s past ability to persuade most of the public to look beyond inflation spikes.
“It’s absolutely fair to then say: is that going to work this time? I don’t know. But that’s all we’ve got. In the end we have to do what we think is right,” he said.
But some officials already harbour doubts. Martin Weale - who in February was the first MPC member to say there was unlikely to be a case for QE in May - said this week that growth had not materialised as expected, strengthening the case for QE.
Moreover, not all economists are convinced that the central bank is on the right track. Simon Kirby, a senior research fellow at NIESR, Britain’s leading macroeconomic think-tank, suggested the BoE’s sudden focus on inflation’s failure to fall quite as fast as forecast appeared arbitrary.
“Just because it’s proved a little bit more sticky than they thought is not a reason to change their view on where the economy is heading,” he said. “The one thing we can say for certain is that the economy is in a very weak position.”
Reporting by David Milliken