An inflation rate more than twice its target did not stop the Bank of England from announcing more monetary stimulus following its latest Monetary Policy Committee meeting.
From the BoE's news release on Thursday:
The Bank of England’s Monetary Policy Committee today voted to maintain the official Bank Rate paid on commercial bank reserves at 0.5%. The Committee also voted to increase the size of its asset purchase programme, financed by the issuance of central bank reserves, by £75 billion to a total of £275 billion.
The BoE justified its latest move by saying that the outlook for economic growth in the United Kingdom has deteriorated. According to the BoE, this made it more likely that inflation -- which was 4.5 percent in August -- will fall and undershoot the 2 percent target in the medium term. It also said that strains in bank funding markets as a result of euro-area sovereign debt concerns may inhibit the availability of credit to consumers and businesses.
The euro-area sovereign debt situation was also obviously a concern for the European Central Bank.
Like the BoE, the ECB announced after its monetary policy meeting on Thursday that it would keep interest rates unchanged. Additionally, it announced the launch of a new covered bond purchase programme which would see it purchase 40 billion euros worth of bonds starting next month. It would also offer banks unlimited 12 and 13-month loans and extend its unlimited funding of banks under its regular refinancing operations at least until July 2012.
In his statement to the press after the monetary policy meeting, ECB President Jean-Claude Trichet said that economic growth in the euro area is expected to be "very moderate" in the second half of the year, with risks to the outlook on the downside because of ongoing tensions in some segments of the financial markets in the euro area. Inflation, which was 3.0 percent in September, will stay above 2 percent over the coming months but decline thereafter.
I show below a chart of the spread between 10-year government bond yields and central bank rates in the UK and Germany. It is interesting to note that the BoE has launched its latest round of quantitative easing at a time when not only is inflation well above its target but the spread between the 10-year yield and the official bank rate is also quite wide by historical standards.
Still, the spreads have deteriorated sharply since early this year in both the UK and Germany, especially in the latter as a result of two rate hikes by the ECB. A narrowing term spread usually indicates a weakening economic outlook.
An economic report out from Germany on Thursday also provided an indication that the economy is weakening. German factory orders fell 1.4 percent in August after having fallen 2.6 percent in July, showing that the euro area's largest economy is struggling to maintain growth.