Why has the Bank of England decided against printing more money despite a recession in Britain, an intensification of the eurocrisis and advice from the IMF that now is the time to act?
The Bank of England has decided to leave interest rates unchanged at 0.5%. It’s also decided to leave its programme of Quantitative Easing – designed to help the economy by pumping money directly into the financial system – unchanged at a current value of £325bn. After some excitement in the financial markets yesterday that it might boost the economy, what might have encouraged the Bank to hold fire? Certainly, there have been plenty of signs in the last few weeks that might have prodded them into action.
In the middle of May, the Governor Sir Mervyn King was sounding in apocalyptic mood when he talked about Britain’s main trading partner, the Eurozone, “tearing itself apart” over efforts to deal with Greece and the other heavily indebted members of the single currency. And he said it would be wholly unrealistic to think that this would not affect the UK. Since then, the “tearing apart” has intensified as concerns have grown over the state of Spain’s banking system.
Shortly after that, we learnt that the recession in the UK was slightly worse than initially thought. And then new evidence from the manufacturing sector in May proved disappointing, showing a sharp decline in activity.
And on top of these gloomy portents, the IMF popped up to endorse the notion of more stimulus for the British economy. Its latest report on the UK called for more “monetary easing”, to include lower interests AND more quantitative easing. The Chancellor George Osborne drew attention to that advice when he hosted the IMF’s visit to London, suggesting the government would be only too happy to see the Bank getting a move on in the battle to stimulate Britain’s moribund economy.
So given the gloomy data and the stamp of approval from the IMF, why might the Bank have held steady?
Some evidence that would have given them pause for thought had dropped onto the desk of the Bank’s policy makers in the just last few hours before they made their decision. A survey of Britain’s service sector – published today at 9.30am – showed that the largest part of the UK economy is still growing steadily.
The Bank will also be focusing on inflation – currently 3% when the official target is 2%. Inflationary pressures have been easing but not as quickly as the Bank had hoped. If that service sector report is correct, and the economy is still ticking over, then Bank officials would be nervous about pumping more money in right now.
Judging the importance of the Eurozone crisis in the Bank’s thinking is tricky. The reality is that – despite the rhetoric about Eurogeddon – there’s a gap between the immediate economic impact of events on the Continent and the potential impact of what might happen.
The reality is that while UK exports to Spain were worth £9.7bn last year, our exports to Germany were worth £32.6bn and our exports to France were worth £22bn. So severe economic problems in Spain (and ofcourse Ireland, Portugal and Greece) might have relatively limited effects on us, so long as the two giants of the Eurozone keep going.
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Whether that will happen is a big question. A crisis in Spanish banking could see panic spread across the the Eurozone financial system, slowing growth everywhere. Right now, the hope is that Europe’s leaders will come up with a fix that prevents that happening. For the moment, the Bank’s calculation may be its better to keep its powder dry and wait to see how the crisis plays out.