Of the major central banks meeting this week, the Bank of England seems the most likely to alter policy. It would not be exactly surprising as three members of the MPC including the governor voted to resume gilt purchases last month.
Most data, outside the some housing price indices and the CIPS service sector survey, warns that the UK economy has failed to catch. To call it a triple dip, as is popular in the press, is a conceptual error because it implies two recoveries. Unlike the US and Germany, the UK economy remains well below its pre-crisis peak.
We had seen the possibility of a stronger sterling bounce following the loss of the UK’s triple-A rating, which had long been rumoured. However, sterling peaked on Tuesday near $1.5200; about half a cent above where it was on the eve of the downgrade. It fell to new lows in late NY yesterday to its lowest level since July 2010 ahead of the BOE meeting.
Even though sterling has eclipsed the yen as the weakest major currency this year, the risks in the UK appear on the rise. The economic challenges are spilling over into politics and it appears to be moving toward a climax.
The Lib-Dems, the junior partner in the governing coalition was never a strong advocate of the austerity now hard-and-fast of the Tories. Their distaste has grown. Business Secretary and Lib-Dem Vince Cable has promised a program of new public investment in schools, roads and housing, but he is not part of the real dialogue.
Prime Minister Cameron and Chancellor of the Exchequer Osborne are moving in the other direction. They are digging in their heels and are not budging from the commitment to the thrust of tighter fiscal and looser monetary policy. This will be reflected in the presentation of the budget on March 20.
There is an implicit understanding that Bank of Canada Governor Carney who will replace King as Governor of the Bank of England in July will be more aggressive in providing the looser monetary policy. However, to be clear, it is not just about the person but the institution.
Cameron and Osborne seem to recognise this. There are reports that they are thinking about changing the central bank’s mandate Under consideration, reportedly, is giving it a dual mandate, like the Federal Reserve, or altering its target to nominal GDP, or allowing a longer period to achieve a 2%.
In a recent by-election the Tories came in third, behind Labour and the Lib-Dems. This is important because the decline in public support for the Lib-Dems weakened their ability to influence government policy. Cameron’s pledge to hold a referendum on the EU after the next election implicitly assumes that Lib-Dem support won’t be needed as it is considerably less anti-Europe than the Tory Party.
The timing and issue offers a window of opportunity for the Lib-Dems. It needs to preserve is brand identity, which is at risk of being overwhelmed by the Tory agenda. Its dilemma is that the Labour Party has been weakened by the internal strife of unhealed wounds from yesteryear between the New and Old Labour and the lack of a compelling vision of the UK’s place in the 21st century.
If the BOE does nothing, sterling may bounce a little, but it will simply increase the likelihood that it moves in April, so it will sold into. Waiting for Carney in July is not how central bankers think. On a GBP25 bln gilt purchase program, which is what the “doves” voted for last time, could see sterling fall initially, but maybe not stay down as it take them out of the game. A larger gilt purchase program would could see a steeper initial drop, perhaps toward $1.4850.
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