Tough decision for BoE in the face of eurozone crisis

  • While uncertainty in the eurozone economy escalates focus now turns to the Bank of England (BoE) monetary policy meeting due on Thursday 10 November at 12.00 GMT. While the UK economy battles to recover from recession, the country's price levels accelerated creating a problematic situation for the BoE.  
  • But the MPC committee is concerned about the country's sluggish growth and the risk of a double-dip recession. During the last few months, the BoE changed its outlook and the members turned dovish abandoning any hawkish comments even while inflation stands stubbornly high. During the last monetary policy meeting, the two hawkish members of the MPC committee Martin Weale and Spencer Dale abandoned their views for higher interest rates resulting in a unanimous decision to keep rates at an ultra low of 0.5%.   
  • This is not an easy decision for the central bank. Consumer Price Index showed an unexpected rise of inflation to 5.2% from a previous 4.5% in the month of September while the central bank's target is only at 2%. If conditions were normal, an escalating inflation would indicate a tightening of the monetary policy. But what happens when the UK economy suffers from a slow growth, a stubbornly high unemployment and the risk of sliding back into a double-dip recession? Recent economic data raise concerns about the UK recovery. Industrial Production, Purchasing Manager Index Manufacturing and Consumer Confidence, Retail Sales and Trade Balance revealed disappointing figures underscoring the country's fragile economic position. Data from the Labour market also made the UK slowdown evident after unemployment rate rose to 8.1% from a previous 7.9%. It is obvious that the UK economy is signalling weaker growth despite an advance in the third quarter Gross Domestic Product as it is expected to be downwardly revised. To make matters worse, the UK risks falling into a dangerous stagflation phase. Stagflation is when an economy suffers from rising price levels and slow growth. It is a troubling economic state that an economy will find difficult to escape from. The central bank is now asked to find the healthy balance between rising prices and a sluggish economic growth.
  • The global economic environment also poses a risk for the UK economy. Last week, the European Central Bank's new chief Mario Draghi surprised investors with a rate cut aimed at calming markets panicked by the eurozone debt crisis. Uncertainty in the debt burden countries Greece and Italy rises. Greece is still struggling to appoint a new coalition government while Italian government bond yields jumped to record high levels raising fears for a eurozone debt contagion. The Governor of the Bank of England Mervyn King said that considering the worsening outlook for the global economy, it was necessary for the central bank to act as it may be the worst financial crisis since the Great Depression.
  • The BoE is expected to hold the benchmark interest rate at 0.5% and maintain its 275 billion pound asset purchasing program after an unexpected 75 billion increase in October and usually no statement is released if policy remains unchanged. A less likely scenario would be that the BoE announces additional monetary stimulus to fight the danger of a falling back into recession which may put the sterling under pressure. Will the MPC committee surprise the markets?

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