BOE to Stay Sidelined as Inflation Remains Strong in the Near-term

The BOE is expected to continue its 'wait-and-see' stance in monetary policy. At Thursday's meeting, the central bank should unanimously vote for keeping the official Bank Rate paid on commercial bank reserves at 0.5% and continuing with its program of asset purchases totaling 200B pound. The Committee will continue to monitor the appropriate scale of the asset purchase program and further purchases would be made should the outlook warrant them.

Economic data released since January's meeting denoted generally fragile outlook in the UK. Although 4Q09 GDP, gaining +0.3% q/q, suggested UK has exited recession, details were not as upbeat as signaled in the headline reading as government spending and inventories contributed to most of the growth. Moreover, claimant counts were also disappointing as they surprisingly jumped +23.5K to 1.64M, the highest level since April 1997, in January. Housing prices dropped for the first time in 10 months, by -1% m/m, in February while retail sales fell in January twice as much as market had anticipated. While these could be attributed by a return of VAT at 17.5%, extremely cold weather and removal of stamp duty relief, poor data indicated sluggish fundamentals in British economy.

The BOE should stay sidelined despite the dovish outlook because inflation has been overshooting the central bank's forecast. Annual inflation rate jumped +3.5% in January, following a +2.9% increase in the previous month. Although the BOE views the rise to be temporary, it will not want to extend QE measures when inflation remains high.