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Thursday, the Bank of England is expected to hold its key interest rate at a record low of 0.50% for a tenth consecutive month in its first monetary policy meeting of the New Year. The central bank is also expected to continue its GBP 200 billion asset purchase scheme to support the economy, which is expected to exit recession soon.
The monetary policy committee led by Governor Mervyn King is set to announce its decision on bank rate and asset purchase at 7.00 am ET.
The current interest rate has been the lowest rate since the central bank was established in 1694. The previous change in rate was a reduction of 0.5 percentage points in March 2009.
In the final MPC meeting of 2009, policymakers decided to continue with its programme of asset purchases totaling GBP 200 billion financed by the issuance of central bank reserves after raising the size in November. Total quantity of assets purchased by the BoE on December 31 stood at GBP 190.05 billion.
Initially on March 5, the central bank introduced a GBP 75 billion programme of asset purchases financed by the issuance of central bank reserves. Later, the size of the quantitative easing was raised to GBP 125 billion on May 7 and again to GBP 175 billion on August 6.
The current quantitative easing measures will be completed by February. Policymakers would possibly reassess the size of unconventional measures only when they release the next quarterly inflation report due on February 10.
U.K. continued to be in recession when other major economies exited the downturn officially. The economy contracted 0.2% in the third quarter of 2009. However, the economy is expected to have returned to growth in the fourth quarter. Among major economies, Japan, Germany and France emerged from recession in the second quarter itself.
As an indication of a significant improvement in the economy by the end of 2009, manufacturing activity improved strongly to 25-month high in December, with robust production and new orders. The country's service sector also continued growth, albeit at a slower pace.
According to Hetal Mehta, Senior Economic Advisor to the Ernst & Young ITEM Club, activity is still increasing at a strong pace in the UK, and given that the service sector forms such a significant part of the economy, it is a further sign that the recession will have ended in the fourth quarter.
Even if the British economy exits recession in the fourth quarter, the sustainability of growth is doubtful as the country faces risks of debt burden. The Chancellor of the Exchequer, Alistair Darling said on January 5 that it is important to reduce debt in such a way that should not disrupt economic recovery. He warned that quick fiscal tightening would derail Britain's recovery.
U.K. is facing a record budget deficit of 12.6% GDP, the biggest among the developed nations. All political parties agree that this level of deficit is unsustainable.
Colin Ellis, European economist at Daiwa Capital Markets Europe Ltd said on January 4 that the BoE policy makers may need to explore more radical ways to kick-start growth if the economy fails to register the expected strong recovery in 2010. The economist expressed concern that quantitative easing may have only limited impact on the real economy, as it did in Japan.
Consumer price annual inflation in the UK rose to 1.9% in November from 1.5% in October, although staying below the central bank's target of 2%. Nevertheless, inflation is likely to rise from January as VAT returned to 17.5% from the beginning of this year. Hence, the inflation rate is estimated to climb to 3% in the earlier part of this year before falling back below the BoE's target by the end.
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