The United Kingdom is currently in a difficult position. With their economic situation looking less optimistic and prices becoming less stable, the Bank of England is going to have to make some very tough decisions in the next couple of months. Does the Monetary Policy Committee do what it can to stimulate growth and be as accommodating as possible to encourage economic recovery or does it do what it can to ensure price stability, which may not be as accommodating if at all to economic recovery? According to the opening clause of the October 2010 Minutes of the Monetary Policy Committee Meeting…
“The Bank of England Act 1998 gives the Bank of England operational responsibility for setting interest rates to meet the Government’s inflation target.”
Minutes Of The Monetary Policy Committee Meeting 6 and 7 October 2010, pg. 1
At the current moment, the Bank of England is failing to meet the government’s inflation target of 2 percent; the current inflation rate is 3.1 percent. Currently the Bank of England is failing to accomplish its sole purpose. Andrew Sentance is the only member on the Monetary Policy Committee who wants to take steps to combat inflation immediately by raising the interest rate by 25 basis points, bringing the target interest rate to .75 percent.
“Andrew Sentance preferred an increase in Bank Rate of 25 basis points, and to maintain the size of the asset purchase programme at £200 billion.”
Minutes Of The Monetary Policy Committee Meeting 6 and 7 October 2010, pg. 10-11
Though increasing the interest rate incrementally will combat inflation, it will have a negative affect on the United Kingdom’s economy. Quantitative easing on the other hand would aid the United Kingdom’s economy. If the Bank of England were to keep interest rates where they are or even lower them and increase the size of the asset purchase program by £50 to £125 billion, it will help stimulate the economy further. Adam Posen, a member of the Monetary Policy Committee, believes increasing the asset purchase program by £50 billion is the way to go.
Adam Posen preferred to maintain Bank Rate at 0.5% and increase the size of the asset purchase programme by £50 billion to a total of £250 billion.
Minutes Of The Monetary Policy Committee Meeting 6 and 7 October 2010, pg. 10
Though increasing the asset purchase program would be beneficial to the United Kingdom’s economy, it will also exacerbate inflation issue. Majority of investors seem to believe that the asset purchase program will be increased for government bond yields continue to fall as investors overwhelmingly believe that the Bank of England along with the Federal Reserve, the Bank of Japan and possibly other central banks will ultimately perform additional quantitative easing as their respective economies continue to stall. Investors seem to also believe that interest rates will stay low for an extended period; which is also contributing to the falling government bond yields.
The Sterling is taking a beating as currency traders believe that additional asset purchases by the Bank of England are inevitable. But with Andrew Sentance pushing to tighten monetary policy, there maybe some slightly short term strengthening of the Sterling. I have and will continue to be short the British Pound for some time. I believe that the Bank of England will either increase the asset purchase program or keep interest rates stable for an extended period of time.