The launch of QE2 at the October MPC meeting was predicted by the “MPC-ometer” model – a statistical representation of the Committee’s decision-making based on 12 economic and financial inputs.
The model, in fact, had suggested that a narrow majority would vote to ease at the September meeting. In recent testimony to the Treasury Select Committee, Bank of England Governor Sir Mervyn King stated that “we came very close to voting for asset purchases in September”.
The model is again at odds with the consensus this month, judging incoming news to be consistent with further MPC easing. This could be in the form of a £25-50 billion rise in the current gilt purchase programme (i.e. to £100-125 billion) although a cut in Bank rate from 0.5% to 0.25% should not be ruled out.
The consensus expectation of inaction is questionable since the October minutes state that the MPC considered a £100 billion initial purchase target and would adjust the programme “depending on developments in the euro area and financial markets” – negative, on balance, over the last month.
In terms of its inputs, the MPC-ometer’s further dovish shift reflects weaker business and consumer surveys, below-par third-quarter GDP growth (after adjusting for the distortion created by the additional second-quarter bank holiday) and wider bank funding spreads – see chart.
The model is designed to predict the immediate policy decision but can be used to forecast further ahead based on assumptions about the inputs. This suggests that QE2 will be expanded by a cumulative £75-100 billion by January (i.e. to £150-175 billion) if current input values are sustained.
The MPC-ometer attempts to predict actual policy rather than that consistent with the inflation target. The view here remains that the UK is not currently suffering from a shortage of liquidity so additional QE is unwarranted and carries significant medium-term inflationary risk.
