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Bank unanimous on May policy

Source: Reuters - Wed 19th May 2010

The Bank of England's Monetary Policy Committee voted unanimously to make no changes to its ultra-loose policy stance this month, but some members thought the Bank's latest inflation forecast was overly optimistic.

Minutes of the central bank's May 7-10 meeting showed there was "a range of views" among MPC members regarding the amount of spare capacity in the economy and how much it could reduce inflation.

Although economic data had evolved broadly as the MPC expected over the past three months, May's decision was framed by uncertainty stemming from developments in the euro zone and the unclear path of Britain's fiscal tightening.

The MPC met just after Britain's inconclusive May 6 election, and before a coalition was formed between the Conservative and Liberal Democrat parties, which have since pledged to accelerate the pace of fiscal tightening.

"It was too early to assess with confidence the overall impact of recent developments on the medium-term outlook. Some of the present uncertainties should be reduced by the time of future meetings" the Bank said.

Bank members voted 9-0 to keep interest rates at 0.5 percent, where they have been since March 2009, and to maintain the 200 billion pound stock of assets purchased under the Bank's quantitative easing policy.

The minutes noted that near-term inflation prospects had risen - a view also shown in the May 12 Inflation Report - but that spare capacity should continue to reduce price pressures in the medium term, despite some signs they were currently rising.

Detailed Inflation Report figures released for the first time on Wednesday showed the Bank had revised up its forecast for Q4 inflation to a modal 2.28 percent from February's 1.53 percent forecast, assuming monetary policy stays unchanged.

A year later, inflation is forecast to have bottomed out around 1.49 percent compared to 1.44 percent in the February Inflation Report.

However, some MPC members said at the last meeting that these forecasts were too optimistic.

"Some members interpreted recent developments in firms' costs and pricing behaviour as potentially suggesting that the dampening effect on inflation from the margin of spare capacity might be somewhat weaker than assumed in the May central projection" the minutes said.

Consumer price inflation unexpectedly hit a 17-month high of 3.7 percent in April, figures released on Tuesday showed, forcing Bank Governor Mervyn King to write a public letter explaining why CPI had stayed so far above its 2 percent target for so long.


Other MPC members placed more weight on downside risks to growth and inflation from the continued reluctance of banks to lend and financial turmoil in the euro zone.

The latest Inflation Report sees modal year-on-year growth of 2.80 percent by the last three months of 2010, little changed from the February forecast.

Economists saw little that was surprising in the minutes, but noted the ongoing tussle on the 9-member committee about the impact of spare capacity, which the central bank is relying on to bring down inflation without the need for interest rate rises.

"There's still evidence of divisions" said Ross Walker, economist at RBS. "They're nuancing a little bit this output gap analysis, which clearly they've got to do in the light of inflation data, but overall there's still a slightly dovish bias there."

Money markets show that most investors do not expect the Bank to raise interest rates before early 2011.

At the time of the MPC meeting, committee members said it was too early to tell how big an impact tensions on euro zone government debt markets would have on Britain's economy, since it was possible that the creation a $1 trillion EU/IMF bailout fund could restore market confidence.

"The only lasting effect of recent developments on UK economic prospects could come about from accelerated fiscal adjustment in the euro area" the minutes stated.

The Bank said that as of May 10, the pace of fiscal consolidation in Britain was uncertain and "would need to be sensitive to sustaining market confidence."

King welcomed the coalition's plans to reduce the budget deficit faster in a news conference on May 12.

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