If You Can’t Beat ‘Em, Join ‘Em!

Yesterday, the minutes of the most recently concluded MPC monetary policy meeting revealed that Adam Posen, one of the two dudes who were rallying for an increase in the asset purchase program, joined the majority in seeking for no change.

This came as an extremely huge surprise to the market because Posen was one of the Bank of England’s (BOE) most dovish members. Last month, he, together with David Miles, had called for a 25 billion GBP increase to the central bank’s asset purchase program.

If I recall correctly, he was also the one who had been aggressively pushing for more easing loooooooooong before the central bank’s decision last October to increase the asset purchase program. Now, Miles is a lone wolf!

According to the minutes, Posen switched his vote because of the U.K.’s old nemesis – inflation! I think this is completely understandable, especially after seeing the CPI report for March. It showed that the inflation rate picked up for the first time in six months, rising to 3.5% from 3.4%.

Though the central bank predicts that inflation will probably fall below their 2% target before the year ends, there are still some risks involved. One such risk is the surging oil and gas prices. Since February, these commodities have jumped 5%. BOE Deputy Paul Tucker said that if this continues, inflation might stay upwards of 3% throughout 2012.

Don’t get me wrong, the fact that one ultra-dovish member decided to switch sides doesn’t necessarily mean that the U.K. has fully escaped the need for stimulus. As a matter of fact, the central bank itself acknowledges that the economy is still in danger of recession.

In Q4 2011, GDP shrank by 0.3%, and rumor has it that the U.K. may see another negative figure when the GDP report for Q1 2012 comes out next week. Keep in mind, back-to-back quarters of negative growth is the textbook definition of a recession!

When it comes down to it, the BOE has to perform a delicate balancing act; it must promote economic growth while keeping prices stable. Right now, with the manufacturing, construction, and services industries picking up steam, it seems that policymakers believe the need to keep inflation in check requires more attention.

So how does all of this affect the outlook for monetary policy?

Well, if you ask me, it seems like this could be game-changer. Just take a look at the charts! Following the release of the MPC meeting minutes, the British pound surged and broke key psychological levels against the dollar and the euro.

GBP/USD and EUR/GBP

Why wouldn’t it? After all, there’s only one member remaining that sees the need to increase stimulus in the short-term. This all but kills hope for further easing in the BOE’s next rate statement! And remember, there were a few market participants who were expecting the BOE to announce another round of quantitative easing (QE) after its current program expires in May.

While we can’t completely rule out more QE this quarter, it’s hard to deny that the probability that the BOE will ease its policy further has dropped significantly. As such, the sky seems to have opened up for the pound. Let’s see if the markets will keep taking it to new heights!

1 comment

  1. HarryPilgrim

    Agreed. Think of Britain as a lightweight Germany with flexible markets and it’s own money. $1.63 and 80p are next. 

    Reply

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