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The Bank of England shocked financial markets when it decided not to expand its quantitative easing programme this month — but it shouldn't have done.
That is not a criticism of Mervyn King and the monetary policy committee for not acting, but those in the City who were so sure another round of stimulus was immediately on the way.
What is plainly clear is that the Bank prefers, if it can, to make big decisions alongside its quarterly inflation reports, so August was always likely to be the date to look for.
It will then have up-to-date projections on growth and inflation, and another month to see what sort of impact the £125 billion it has already pumped into the economy has had.
Deputy Governor Charlie Bean, on a tour of the country to explain the programme, said as much today, remarking that the scale and nature of quantitative easing means it must be judged quarterly.
“In principle, we decided every month, but in practice it does not make sense to fine-tune the amount we spend by a few billion here, a few billion there,” he said. “It is natural to take stock... each quarter.”
So the minutes of this month's meeting, which will be published tomorrow, are more likely to suggest that the view on Threadneedle Street this month was one of “wait and see” rather than anything more conclusive.
Printing more money will certainly have been discussed, although the Bank is keenly aware of the need to implement an exit strategy when the time is right, probably in the form of a rise in interest rates.
“At some stage, as the economy starts recovering, we will have to withdraw the stimulus,” explained Bean.
“It is quite likely we will in the first instance raise Bank rate. We can then start selling the assets we have bought at a rate which recognises the market circumstances at the time.
“In terms of the trigger, the key thing will be the inflation outlook. When we think the recovery is such that it looks like the risks are that we will overshoot the 2% inflation target, we will need to start withdrawing the stimulus.”
Bean emphasised the importance of the volume of money in the system, rather than the flow — a hint that even if the Bank does not make more purchases, it will leave funds already provided in the system as long as possible.
But, after the shock of this month, the City is now convinced quantitative easing will be expanded next month, perhaps even above the £150 billion limit set so far.
But is this the right approach?
Supporters insist the Bank must flood the economy with more cash to stave off a dangerous bout of deflation and stimulate recovery.
But the Consumer Prices Index — the dubious measure of inflation favoured by the Government — has not fallen as far or as fast as expected and is only just below the 2% target at 1.8% having peaked at 5.2% last year.
Inflation looks set to fall further, but there is every reason to think it will not undershoot the target by as much as feared. Indeed, it would be no surprise for the Bank to raise the path it thinks inflation will take next month.
Given the stubborn path of inflation so far, and the obvious inflationary impact printing money has, now may not be the right time to pump yet more cash into the economy.
As Bean said, taking the sting out of rising inflation will require interest rates to go up and go up sharply — something that could kill off economic recovery before it even gets started.
There are also concerns quantitative easing is not working, with banks hoarding funds rather than lending to businesses and consumers.
Adam Posen, the American economist who joins the monetary policy committee in September, was in forthright mood when he appeared before MPs last week.
“The risks right now are more about deflation than inflation,” he said. “Once you fall into a deflationary situation, it is very hard to get out. Interest rate cuts and quantitative easing combined with the fiscal stimulus is the right way to face this.”
This may be the case. But given the risks and expense of quantitative easing and the uncertainty over how much it is actually doing for the public and the recovery, it is about time Westminster and the City held a proper debate over whether it is or not.
