BOE Considered Expanding Stimulus in 7-1 Vote Against Sentance

The Monetary Policy Committee, led by Governor Mervyn King, voted 7-1 to keep the benchmark rate at 0.5 percent, according to minutes of the July 8 decision released in London today. Sentance favoured an increase to 0.75 percent, arguing that inflation had “shifted sufficiently to justify beginning to raise interest rates gradually.”

“On balance, most members thought that it was appropriate to leave the stance of monetary policy unchanged,” the minutes said. “The committee considered arguments in favour of a modest easing in the stance of monetary policy. The softening in the medium-term outlook for GDP growth over recent months would put further downwards pressure on inflation, once the impact of temporary factors had waned.”

Sentance’s push comes as the government implements the biggest spending cuts since World War II to cut the budget deficit, threatening the economy. Since he first voted for an interest-rate increase in June, officials including David Miles have attacked his position, saying inflation is likely to cool and there is a risk the recovery may falter.

The policy makers voted unanimously to keep the size of their bond holdings at 200 billion pounds ($306 billion), the minutes also show. They bought government securities from March 2009 until January this year to fight the recession.

Pushed Down

The pound remained higher against the dollar after the minutes were published and was little changed at $.15279 as of 10:53 a.m. in London.

The Bank of England officials said that while the impact of the budget measures on the economy were “hard to gauge,” it was “likely that they had pushed down a little on the most likely path for output.” They also noted indications that the medium-term outlook for growth “might have weakened too.”

While it was “too early” to fully assess the effect of the budget on inflation, they said the planned value-added tax increase would probably add to consumer-price growth in 2011.

“In the light of the news over the month, it seemed likely that growth would be weaker than previously expected but, at least for a while, inflation was likely to be higher,” the minutes said. “The committee’s central view remained that the substantial margin of spare capacity was likely to persist for some time and would bear down on inflation over the medium term.”

Inflation

The U.K.’s inflation rate rose to a 17-month high in April and was at 3.2 percent in June, above the government’s 3 percent upper limit. Consumers’ expectations for price increases climbed to 3 percent last month, the highest since September 2008, Citigroup Inc. said June 30, citing a YouGov Plc poll.

King said June 16 the central bank shouldn’t react to faster inflation based solely on oil-price and exchange-rate fluctuations.

The pound has fallen by about 25 percent since the start of 2007 against a trade-weighted basket of currencies. Policy makers said today there were “considerable uncertainties about the pace and scale” of the impact of this decline on inflation.

Sentance said on July 13 that the economy needs “a gradual withdrawal of some of the stimulus” to keep it on a “low inflation path.”

‘Three-Way’

Other policy makers disagree. Miles said in a speech released last week it isn’t time to raise interest rates as the banking system remains fragile and threatens to undermine the recovery. His colleague Adam Posen said that the economy is ‘tentatively” in recovery, “but still subject to switching back into the recession state.”

Former Bank of England official Sushil Wadhwani said July 14 it’s possible that a “three-way” split may emerge on the committee this year.

Manufacturing and services growth slowed last month and consumer confidence fell to its lowest in a year. The cuts announced in the emergency budget will slice 85 billion pounds from expenditure, equivalent to 5.7 percent of gross domestic product, according to Institute for Fiscal Studies estimates.

In the U.S., the Federal Reserve last month trimmed its forecasts for economic growth this year to 3 percent to 3.5 percent and pledged to keep interest rates near zero for an “extended period” to sustain the recovery. The European Central Bank in May began buying government bonds to contain the effects of the region’s debt crisis and says its current level of interest rates is “appropriate.”