BOE King Testifies in Front of Parliament in Inflation Hearings

The Governor of the Bank of England went up in front of Parliament to hold the quarterly Inflation Hearings. He had some interesting points which can help give us clues as to what the Monetary Policy Committee of the BoE is focused on.

The MPC debate is centered around how quickly inflation can come back to target. We know some of the factors that will help inflation cool - spare capacity and fiscal consolidation over the next 5 years that will weaken domestic demand and thereby prices. Inflation is expected to stay above the 3% level throughout 2011, which means will be writing inflation letters after each CPI releases (if inflation is above 3% a letter needs to be written).

There's no chance that the BoE cuts rates below its current rate to try and stimulate the economy, but on the flip side he said that hiking interest rates to make a gesture to markets was self defeating. The MPC instead will be looking at the medium term outlook for inflation which is anchored in what happens with medium term expectations as well as wages. The MPC is paying great attention to wage negotitations.

That's our main clue as we look over the data. If wages start climbing, then inflation expectations are being passed through to medium term and BoE will have to act. So far, King says there isn't much evidence of a pcik up in medium-term inflation outlook.

The worry is also that by having inflation above the target inflation target for long enough, the risk to inflation expectations also increases.

Another pressure point is the recent jump in oil prices. How long the recent increase in oil prices lasts will impact prices going forward. The MPC will be faced with some difficult choices if we see further increases in energy and commodity prices.

King's comments were followed by deputy BoE Governor Bean. He expects growth to resume in Q1 2011, but underlying growth in Q4 2010 and Q1 2011 looks weak. It remains unclear if the economy hit a soft patch or its a more durable slowdown. He too sees inflation above the inflation target, probably 4-5% through much of this year. That concerns him, as he believes now that the period of elevated inflation may last longer than he first though as the balance of risks to inflation has been shifting upwards in recent months.

What does this mean? It seems that Bean was the bad cop to King's good cop routine. It's an unclear picture in terms of growth, but inflation will remain higher throughout this year and the BoE will likely have to move on rates before long. Markets are pricing in a move in May.

Stronger readings on the economy will make it easier to hike rates, while softness in UK data may make the decision a lot more difficult.

Overnight Data Supports the Case that UK Economy Picked Up to Start 2011

Data from overnight was generally positive which helped to support the GBP.

The Manufacturing PMI came in at 61.5 for February, matching the forecast, and the same pace of increased activity as January. A weaker GBP has helped make UK exports cheaper abroad, helping to keep the manufacturing sector strong even as domestic demand and consumption lags.

Housing prices rose 0.3% in February, compared with a 0.2% contraction.

New mortgage approvals were up 45,723 in January, better than the median forecast of 43,000. Mortgage lending was up £1.8 billion, also much better than the median forecast of £0.15B, and the highest level since February 2010. However, January consumer credit fell £0.333B, weaker than forecast, and shows us that the UK consumer continues to retrench.

With some new risk aversion appearing because of protests in Saudi Arabia the GBP's rally against the CHF and JPY were stalled and reversed, but overall today's developments underscore the current sentiment in markets. The UK central bank will be raising rates as long as economic data doesn't disappoint to the downside too dramatically.

Today we saw good signs from manufacturing and housing, even if consumers may be borrowing less. That helped to support the GBP and put it above that important resistance level.