Bank of England policymakers split earlier this month over how much extra money to pour into Britain's recession-hit economy, with Governor Mervyn King voting unsuccessfully for a bigger 75 billion pound boost. The shock voting pattern revealed by minutes to the central bank's August 5-6 meeting boosted bets that British interest rates would stay at rock-bottom until well into next year.
Sterling fell nearly a cent against the dollar and short-dated gilt yields fell towards record lows as investors contrasted the BoE's aggressive easing stance with that of other central banks starting to wind down unconventional measures. King was joined by Timothy Besley and newcomer David Miles in opposing the other six members of the Monetary Policy Committee who voted for a 50 billion pound ($82.33 billion) boost to the bank's quantitative easing scheme.
It was only the third time King has been outvoted since taking office in July 2003 and the first time he has been outvoted when taking a more dovish stance. The King camp on the Monetary Policy Committee argued that the risks of providing too much stimulus - achieved by buying mostly government bonds - were less than of providing too little, and additional liquidity could be easily mopped up.
Those arguing for a more moderate increase felt the worst of the recession had already passed, and there was a risk of pushing up asset prices. All members agreed, however, that "substantial further asset purchases" were needed and that rates should stay at 0.5 percent.
"This clearly suggests that the Bank is leaving the door open for additional measures," said Peter Dixon, economist at Commerzbank. "QE is still very much in play." The government played down the split vote and welcomed the central bank's pro-active approach on QE. "The important thing is that they agreed to put more money into the economy," finance minister Alistair Darling told the BBC. "That, together with the measures we've taken, ... will help our country come out of recession and will help us grow in the future.
News that some BoE members wanted to pump even more money into the economy raised eyebrows, particularly after Tuesday's surprisingly strong inflation data. Price pressures in Britain have been slower to ease than in many of its trading partners. Yet the BoE's quantitative easing programme, at 175 billion pounds or 12.6 percent of GDP, is more aggressive than any other central bank's.
The decision to increase QE by 50 billion pounds this month was itself a jolt to markets which had been split over whether there would be any increase at all. The US Federal Reserve voted last week to slow its asset purchases while the European Central Bank has never embarked on QE in any meaningful form.
"I think possibly the Bank's forecasts on inflation are a little bit too low," said Brian Hilliard, chief UK economist at Societe Generale. Equity markets have rallied strongly since March and the minutes showed some discussion that pumping too much money into the economy could "result in unwarranted increases in some asset prices that could prove costly to rectify".
Nevertheless, the BoE is convinced that the recession has created enough slack in the economy to keep price pressures subdued. Projections published by the central bank on Wednesday show inflation would have come in at 1.42 percent in two years' time when factoring in previous market expectations of interest rate increases early next year.
If interest rates remain at 0.5 percent throughout the next two years, inflation is forecast to come in at 2.17 percent, only slightly above the BoE's 2 percent target. At the same time, the BoE is forecasting a relatively robust recovery, with the economy expanding more than 3 percent in 2011. "Amidst huge uncertainty, the BoE would rather err on the side of too much stimulus rather than too little, and appear unconcerned at present that their approach could produce a messy exit strategy later on," said Michael Saunders, an economist at Citi.
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