Bank of England and European Central Bank to maintain rates

The Bank of England's Monetary Policy Committee (MPC) has a stated goal of 2.0% inflation and a meeting on June 10 to decide their future interest rate policy. Nevermind that April's Consumer Price Index came in at 3.7% and its Retail Price Index - which has an even longer history - was at 5.3%, the MPC has been content to pass on opportunity after opportunity to raise the UK Bank Rate from its current record low level of 0.5%. Central Banks the globe over are maintaining record low interest rates, but nowhere is inflation as noticeably elevated as in England. The US reported April CPI at 2.2% and the Eurozone had a 1.6% rate for May. Why is England's so high?

• depreciation of the Sterling (over 4% in the past month)
• restoration of the 17.5% Value Added Tax (VAT) in January 2010
• oil prices rising nearly 70% from prior year
• loss of supply capacity due to the downturn
• businesses opting to maintain profit margins in this reduced credit environment, rather than cut prices to boost sales

It's quaint to think that just this past September, the UK reported a pithy 1.0% inflation. Of all the functional and moral responsibilities in setting the bank rate, surely among the most pressing is saving the average man from forces outside his control declining value of his money.  Just last week the OECD advised the MPC to get Bank Rate back up to 3.5% by the end of 2011. 

This begs the question: What is the MPC thinking? Are they wary of quashing the sprigs of recovery with too-high interest rates? Is it that some inflationary factors, like the VAT and oil prices, may stop bolstering the rate soon? Is England perhaps embracing a hyperinflation policy to "inflate away" its staggering public and private debt? Or is the MPC ready to change its mind? 

We polled our experts and came upon a unanimous, resounding "MAINTAIN" forecast. Here are some reasons why:

• Michael Malpede, Easy Forex:
  "The BoE will maintain steady rate policy and the current level of asset purchases because the UK recovery is uneven and the new governments plan to cut the record UK budget deficit is a risk to the recovery. UK inflation has been rising and if the rise continues the BOE may be forced to move towards a normalization of rate policy before year end."
• Trevor Williams, Lloyds Banking Group: 
  "The BoE will maintain rates. Volatility has returned to markets and risks to growth are downside from weak activity in the United Kingdom's biggest trading bloc, the European Union. The Bank of Canada may have raised rates, but Canada is in a unique position, benefiting from recovery in US and strong rise in commodity prices, plus good fiscal position before crisis started."
• Ashraf Laidi, independent global markets analyst:
  "The BoE will maintain steady rate policy and the current level of asset purchases because the UK recovery is uneven and the new governments plan to cut the record UK budget deficit is a risk to the recovery. UK inflation has been rising and if the rise continues the BOE may be forced to move towards a normalization of rate policy before year end."
• Piet Lammens, Head of Treasury and Capital Markets, KBC:
  "The BoE will maintain rates due to prevailing economic weakness, still-weak banking sheets and a preference for a weak Sterling."
• Kathy Lien, Director of Currency Research of FX360 and GFT:
  "BoE will maintain rates - Like the Eurozone, the U.K. has a host of budget problems. However they are in much better shape than the ECB but with the new government expected to announce a barrage of measures to bring down the deficit, the BoE will most likely postpone any normalization of monetary policy until there are clear signs that the recovery is sustainable."

The European Central Bank (ECB) also has a stated goal interest rate of 2.0%, but unlike the Bank of England the ECB has been dealing with a perpetually below-target inflation rate. Eurozone inflation was at 1.6% for May, having risen almost continuously from 0.5% in November 2010.  The Eurozone is not exactly frothing with growth, as per the weak retail sales and industrial production data released this past week, and the ranks of Euroarea nations under austerity plans seems to grow by the day. 

The ECB is facing more complicated questions than just the standard yes/no on interest rate increases expected of a typical central bank. Despite 11 years of monetary union, rifts in the competitiveness and fiscal profiles of more productive nations like Germany, and less-so ones like Greece make it difficult to frame a monetary policy suited to all but the weakest members. 

Besides appeasing inflation-wary German Bundesbank heads, whose nation is currently benefitting from low-Euro-driven export growth, an interest rate hike may regain some of the ECB's credibility, which it reluctantly tendered as the multi-country bank proceeded to purchase member state-issued bonds in May at generous prices - a form of monetary easing in itself. The ECB was one of the few, the proud, who were not joining the quantitative easing bandwagon up until that point. Perhaps on June 10th, the bank would reverse course.

 

We polled our experts and came upon a unanimous, resounding "MAINTAIN" forecast. Here are some reasons why:

• Michael Malpede, Easy Forex:
  "The ECB has little choice but to maintain steady policy because of concern that the EU debt crisis and new austerity measures will curb growth."
• Trevor Williams, Lloyds Banking Group: 
  "The ECB must maintain rates. The Eurozone economy is weakening and has to deal with sovereign risk risk issues."
• Ashraf Laidi, independent global markets analyst:
  "With the ECB already buying bonds, it performing an implicit monetary easing. It will keep rates unchanged at least into the rest of the year."
• Piet Lammens, Head of Treasury and Capital Markets, KBC:
  "The Eurozone is facing a crisis in its government debt market; the ECB must maintain rates."
• Kathy Lien, Director of Currency Research of FX360 and GFT:
  "With the financial situation of European nations in disarray, the ECB will remain dovish and continue to provide monetary support for countries that are actively reducing their budget deficits. I fully expect the ECB's normalization of monetary policy to lag behind the Fed and other major central banks."