Market Outlook - BNP PARIBAS - Investment Services India

should be particularly true for the immediate quarter
or two.
Further ahead, the revisions to the projections are a
little less obvious. In the past, an upward revision of
1 percentage points to the first three quarters of the
inflation projection tends to translate into an upward
revision of 0.3pp two years ahead. This would
suggest that the likely 0.5pp upward revision to the
Q1 2010 projection will probably add around 0.15pp
to the two year ahead projection (which was trending
up quite sharply at that point anyway).
That said, sharp increases in inflation around the
start of 2010 due to the VAT hike will drop out of the
y/y calculation in early 2011. This may dilute the
extent of the upward revision two years out.
The other major news has been the disappointing
GDP data. We suspect that the BoE will take the
view that the initial print of 0.1% q/q expansion in Q4
GDP will be revised higher. Furthermore, the
evolution of the survey indicators suggest the nearterm
GDP projection is largely on track. We therefore
doubt that there will be a significant revision to the
growth outlook, though this may be an excuse to
moderate the upward revision to the inflation
forecast.
In sum, we suspect that the two year ahead inflation
projection on the basis of unchanged Bank Rate will
be moved upwards to around 2.5% y/y – mainly due
to the fact that the projection was trending sharply
higher at the two year ahead horizon last time
around.
The inflation projection based on market interest rate
expectations will take account of the above, plus
changes in the interest rate outlook. Last time, the
two year and one quarter ahead projection was
1.8%. Since November, expectations for hikes in
Bank Rate have been scaled back by around 50bp.
However, gilt yields have risen by around 20bp. We
judge that the net result is there should be a modest
additional upward revision to the two year ahead. In
sum, that projection should be around 1.9%, but
could be as high as 2%.
A word of caution is warranted here. In the past this
kind of mechanical calculation has been very
effective. However, there was an element of fudge in
November 2009. Mechanically, the Bank could easily
have revised up its two year ahead inflation
projection by 0.5pp. Yet the Bank revised up the
projection by just 0.15pp. This suggests uncertainty
about what impact spare capacity will have on
inflation further ahead exerted some restraint on the
revisions. This could be evident again in the
February projections. It also highlights that the Bank
lacks faith in its prior assumption that inflation will
reaccelerate in late 2011, despite a persistent output
gap.
Secondly, the Bank has warned a number of times
that given the uncertainty facing data around the turn
of the year – not least the VAT hike which the Bank
said it will look through – the MPC is not likely to read
too much into the recent upward surprises. To some
extent there is also an element of weather-related
distortion, which should prove temporary. Both
suggest a risk of some restraint in revising up the two
year ahead projection.
Wait and see mode
The combination of the two inflation projections make
a strong case for the committee announcing a pause
in its purchases of gilts. This adds to the hints in the
minutes and recent MPC commentary that suggested
a further expansion in purchases was unlikely.
In particular, the minutes failed to mention the
widening spread between gilt yields and OIS
contracts of corresponding maturities. The December
MPC minutes explicitly stated that the prior narrowing
in this spread had been used by the committee “as
an indicator of the positive impact from the asset
purchase programme”. The narrowing in this spread
unwound further ahead of the January MPC, yet
there was no mention of this in the minutes. We
suspect the committee did not want to entertain
hopes of a further expansion in QE only to
disappoint.
Furthermore, the discussion of developments in
adjusted broad money growth refrained from talking
about the depressed growth rate of headline broad
money growth. Instead, the minutes highlighted the
change in GBP levels and referred to one component
of broad money that had been bouncing back.
We interpret these as tactical hints that the
committee is not keen on expanding the asset
purchase programme further. There was good
reason for the minutes to emphasise the positives.
The latest data on lending have shown tangible signs
of improvement. In particular, lending to non-financial
corporations (although volatile) has been on an
improving trend since mid-2009. Moreover, smaller
firms (who should be finding it harder to source
credit) also saw lending growth reaccelerate in the
final portion of 2009 (Chart 3).
All considered, we expect this week’s MPC decision
to announce a pause in the asset purchase
programme. The Bank is likely to say that the effects
of past purchases are still working through the
system and it would be wise to observe the effects of
past easing. This decision is unlikely to be presented
as the end of QE. Rather, the MPC stands ready to
Alan Clarke 29 January 2010
Market Mover
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