The Bank of England?s (BoE) November quarterly Inflation Report was more dovish than expected, coming as it did after the UK?s disappointing third quarter data the previous month and Fitch?s warni
The Bank of England?s (BoE) November quarterly Inflation Report was more dovish than expected, coming as it did after the UK?s disappointing third quarter data the previous month and Fitch?s warning about the country?s AAA credit rating just the previous day. While it was welcome to have a more positive outlook on the economy, it does however suggest that interest rates may stay at 0.5% for longer than expected.
The Report predicts that the economy will return to growth at the beginning of next year and then grow to around 3.75% within two years – an improvement on the August Inflation Report. Gross Domestic Product is expected to rise above 4% in early 2011 before dropping back to 3% by the end of 2012.
The BoE also said that it expects last month?s figures from the Office for National Statistics ? which showed the economy was still in decline – to be revised upwards.
Unemployment figures were also better than expected, revealing a significant slowdown in the rate people were being laid off work.
At its November interest rate meeting the previous week the BoE kept interest rates at 0.5% for the eighth month in a row. Interest rates are likely to remain low for the foreseeable future and, along with the BoE boosting the quantitative easing programme by ?25 billion to ?200 billion and the depreciation of Sterling, should help the UK?s economy, said the Bank?s Governor, Mervyn King.
The Report calculates that inflation would rise above 2%, from the current 1.1%, before dropping again to around 1.6%. It will remain below 2% in two years time if interest rates rise from the middle of next year as markets have been expecting.
Since the Bank?s mandate is to keep inflation at 2%, this implies that it will not be in any hurry to start increasing interest rates so as to prevent inflation undershooting its target.
In October, the average forecast of economists polled by Reuters was for the BoE to maintain the interest rate at 0.5% until at least July 2010. The rate was then expected to rise to 0.75% by September and 1.0% by the end of 2010. Following the November Inflation Report, however, economists now do not expect the rate to rise until late in 2010.
There would be a spike in inflation to around 3% early in 2010 mainly due to higher petrol prices and the VAT rate returning to 17.5% on 1st January after it was cut to 15% to encourage spending.
King warned that “inflation has been unusually volatile recently. It is currently 1.1%, having been 5.2% only a year ago. Such volatility is likely to continue in the short run?. The report also that ?there are significant risks to the inflation outlook in each direction?.
The report looks ahead two years, and it is very possible that over the longer term inflation will climb higher. Oil prices have risen this year and stimulus packages and quantitative easing measures could also push prices higher once the recovery is under way.
If the BoE now stops pumping more money into the economy through quantitative easing this could put pressure on the interest rate to increase. King said that the Bank had not yet made up its mind about quantitative easing and that the smaller than expected extension to the programme the previous week did not necessarily mean it had come to an end. ?It certainly would be wrong to conclude we've decided that. We've made no judgement at all, we've a completely open mind whether to do more asset purchases or not.?
The Inflation Report also highlighted the UK?s spiraling national debt. It warned that the economy had ?only just started along the road to recovery? and that the Government needed to come up with a ?credible plan? to substantially reduce the fiscal deficit.
King stressed that long-term damage had been inflicted on public finances due to the unprecedented borrowing. The deficit would continue without ?significant fiscal consolidation?. Latest figures from the Treasury forecast a national debt of ?792 billion for the 2009-2010 fiscal year swelling the total debt to ?2.3 trillion.
The UK government had received another warning on its debt the previous day, when international credit rating agency Fitch warned that Britain is the country most likely to lose its gold-plated AAA credit rating unless serious efforts were made to control spending and reduce the debt. Fitch said that the UK faced the ?the largest budget adjustment? of the four major economies that retain an AAA rating on their national debt. The loss of the rating could push up taxes and tighten spending and would increase Britain?s borrowing costs on the international money markets.
Sterling fell on the news. It lost more than a cent against the Dollar dropping to $1.66. Sterling also fell a cent against the Euro to ?1.11.
Prime Minister Gordon Brown commented: “We have assured people that, as a result of our deficit-reduction plan that we announced in our Budget in April, we are taking the necessary action to cut our deficit by half.?
In May, ratings agency Standard & Poor?s altered its outlook for the UK economy from ?stable? to ?negative? indicating it would wait to see what concrete steps were introduced in 2010 to reduce the deficit before reviewing the outlook decision.
Latest unemployment figures were encouraging for the health of the economy. They showed that while unemployment rose by 30,000 to 2.46 million between July and September, it was the smallest rise since the spring of 2008. Economists were expecting unemployment to reach 2.5 million now and 3 million next year. The unemployment rate was 7.8% which was 0.2% below the expected 8%. Between April and June the rate was 7.9%.
The UK Inflation Report is an in-depth analysis of the economy, inflation and growth forecasts upon which the BoE fixes the interest rate. Interest rates are predicted to remain low for three to five years at least and once the economy rebounds higher inflation could well take hold. A wealth management and financial adviser like Blevins Franks can steer you in the right direction to receive an investment growth higher than bank interest rates and designed to protect you from a longer-term rise inflation.
By Bill Blevins, Managing Director, Blevins Franks
13th November 2009