Bank of England March MPC decision

As expected, the Bank of England left both aspects of its monetary policy on hold. Interest rates remained on hold at 0.5%, where they have been since March 2009 and the asset purchase facility stayed at £200 billion, with further increases in quantitative easing not ruled out but unlikely until after the General Election.

In the lead up to the March Monetary Policy Committee meeting, the official estimate of growth in the final quarter was revised up from 0.1% to 0.3%, as we had expected. However, the latest data showed that government spending, the inventory cycle and a mini-bounce in consumer spending drove growth while the private sector recovery remained relatively fragile with business investment slumping again.

In early 2010 there have been signs that the consumer spending recovery is stumbling as real growth in household incomes remained weak. Indeed, retail sales declined sharply in January as the VAT rate was reversed. In addition, mortgage lending fell sharply in January following the end of the stamp duty holiday, preceding declines in house prices on both the Halifax and Nationwide measures. The Halifax house price index fell by 1.6% in February, the first decline since June 2009 and the largest since April 2009. So, there are reasons to be cautious over the strength of the recovery.

Since the last meeting, Bank of England Governor Mervyn King has been forced to write to the Chancellor to explain why inflation exceeded the upper limit of the 1.0% - 3.0% target range. Inflation reached a ten month high at 3.5% in January, but this mainly reflected the effect of the VAT reversal, base effects from the swing in commodity prices over the last year and the ongoing effects of sterling depreciation. We expect inflation to be above target for the first half of 2010 but to fall back later in the year as substantial spare capacity remains in the economy.

In the face of a weak recovery and above target inflation the Bank kept monetary policy on hold again. However, the key variable ahead is what action the government of the day decides to take on the public sector deficit after the election. In many ways, monetary policy is in limbo until the scale and pace of fiscal tightening becomes clear. This uncertainty has led to markets becoming increasingly edgy about the United Kingdom economy - with sterling sliding to a ten month low against the dollar on Monday. It is clear that both the Bank of England and markets are in need of clarity on the policy mix ahead.