Bill Jamieson: Still walking a tightrope

Published on Thursday 5 November 2009 21:27

FOR central bank policymakers, the key dilemma remains: what is the greater risk: acting boldly and doing too much, or acting cautiously and doing too little?

The economy is still highly fragile. But, despite growing expectations that the Bank's monetary policy committee would go full throttle and boost its quantitative easing programme by 50 billion, it has opted instead for a more modest 25bn.

It indicates that the economy is still in need of a boost. But it may also indicate growing divisions within the MPC as to how much further it could go with monetary stimulus without triggering an inflation take-off, with strengthening economic recovery next year. It wants a "little bit" of inflation. But it is dealing with volatile materials – "QE" could work like splashing kerosene on a smouldering fire.

Arguably, the most pregnant line in the MPC statement yesterday is its warning that "inflation is likely to rise sharply to above the 2 per cent target in the near term, reflecting higher petrol price inflation and the reversal of last year's reduction in VAT".

CPI inflation once again overshot the MPC's forecast in the third quarter, and these comments suggest the MPC has probably again raised its near-term inflation forecast.

Citigroup economist Michael Saunders says that if the VAT cut is restored, CPI inflation could rise above 3 per cent year-on-year in the first half of next year. Gilts may continue to benefit short-term, but more of the extra stimulus may find its way into corporate bonds.