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MPC Meeting Minutes: Not as Bullish as You Think!

Jan. 28, 2011 6:47 AM ET
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Forex Gump's Blog
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Well, well, well... It seems the wolf pack has grown by one! Andrew Sentance, a former lone wolf calling for a rate hike, has found a bro in Martin Weale, according to the latest monetary policy committee (MPC) meeting minutes. In the MPC's January 13 meeting, Sentance and Weale voted in favor of tighter monetary policy.

But the two bros will need more members to join their camp if they're looking to hike rates by another 0.25%. As of the moment, the MPC looks as though it's split into three ways as to what it should do.

On one end of the spectrum, we have Sentance and Weale pushing for a rate hike. At the other end, we have Adam Posen, who has remained true to his dovish feathers and is still voting to expand the Bank of England's bond-buying program by 50 billion GBP. And in between the two extremes, we have the majority of the MPC. Six members believe the BOE should maintain its wait-and-see approach and keep its bond-buying program as is.

Naturally, pound bulls did their thing when they received news that the hawkishcamp grew in number. Now that there are two MPC members supporting tighter policy, rate hike-hopefuls have become even more optimistic. The end result? GBP/USD erased half its losses from Tuesday's upsetting GDP data!

It's no mystery that the main reason behind Sentance and Weale's hawkish stance is U.K.'s stubbornly high inflation rate. Inflation has been consistently above the BOE's 2% target for over a year now, going as high as 3.7% last December.

Here's a neat little visual for ya'll:

 U.K. inflation rate

According to a speech by BOE Governor Mervyn King on Tuesday, the high level of inflation in the country is due to the 20% jump in import prices, the fall in the pound's value in 2007 and 2009, the rise in world energy prices, and the increase in the VAT rate. He also said that inflation may go as high as 5% in the next couple of months.

However, rising prices isn't the only factor to consider in deciding whether or not to hike rates. Our BOE chaps also have to check whether economic growth is sustainable enough to weather a rate hike.

But keep in mind, these minutes are from a meeting held a couple weeks before the disappointing GDP results hit newsstands. This means that the MPC members hadn't taken into consideration the GDP contraction in Q4 when they cast their votes back in January 13.

In fact, I believe we may even see further quantitative easing for the U.K.based on the 0.5% contraction we saw in the fourth quarter of 2010. Perma-dove Adam Posen hasn't lost to the hawks yet!

Also, remember that austerity measures are coming into full swing this year. A rate hike would be a double whammy for the Britons because it would make borrowing more expensive. Consequently, this would weigh down on consumer spending which is the main driver of economic growth.

With that said, you may want to be extra careful in rooting for the pound. Its recent gains have been because of the prospect of a rate hike and could be nothing more than a relief rally. I think I even see a potential head and shoulders pattern on the daily chart of Cable!

 U.K. inflation rate

It's hard to say what the BOE's next step will be. There's still too much uncertainty ahead of the British economy for it to take a stab at inflation or pull the trigger on quantitative easing.

This humble old (but devilishly handsome) man shares the opinion of the MPC majority: at this point in time, the best thing to do is to resort to the good ol' wait-and-see approach.

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