Bank warns on money growth

By Christina Fincher

London (Reuters): In a speech to mark the 10th anniversary of the central bank's independence on Wednesday, Bank of England governor Mervyn King identified better analysis of monetary indicators a key challenge for the future, and said it planned to devote more resources to this area.

The usefulness of money indicators to gauge inflationary pressures divides members of the bank's Monetary Policy Committee (MPC), but King has recently put increased emphasis on the link.

"The practical problem facing all central banks is how to distinguish between shocks to the demand for money and shocks to its supply," said King. "After a period of rapid financial innovation during which shocks are predominantly to the demand for money, it is understandable, though unfortunate, if monetary developments are given insufficient attention in the analysis of the inflation outlook."

Inflation has picked up to its highest level in more than a decade, prompting criticism from some quarters that the bank has ignored consistently high money supply-growth.

The bank is widely expected to raise interest rates to 5.5% next week, and markets are pricing in a further quarter-point hike.

Data earlier on Wednesday showed M4, a broad measure of the money supply, running at an annual 12.8%. This is just short of a 16-year high hit last September and well above the bank's 2% inflation target.

Supply shocks

King said many modern models of inflation tended to focus more on shocks to the demand for money - which may have few implications for spending or prices - rather than supply-shocks, such a growing willingness by banks to extend credit to borrowers.

"It is quite possible, in the real world, for there to be unwarranted money supply-shocks," he said. "The MPC must always be looking for warning signals of this."

King said those who felt money supply could be ignored, because warning lights would be seen in other indicators, were being complacent since flashing monetary signals could be the first sign something was wrong.

"The growth of money and credit may signal in advance of other indicators that the bank rate is set at a level inconsistent with bringing inflation back to the target in the medium term."

Looking back at the last decade, he said the central bank could take credit for the unusual stability of the economy but admitted there was "room for improvement" in its communications policy.

The bank has delivered three interest-rate rises since August 2006, two of which caught the market by surprise.

A Reuters poll on Wednesday showed just over half the 49 economists questioned thought the bank had become less effective in communicating policy over the past year.

Some commentators have suggested the process would be more transparent if the bank published interest rate forecasts, similar to those released by central banks in New Zealand, Norway and Sweden.

King said a compelling case for this had yet to be made, but the bank would strive to improve the quality of its publications to allow financial market participants to form their own interest rate expectations.

In a separate interview, King said he viewed favourably a demand from economists for "something to guide them on how to interpret the future data as they come out, as they want to know how we are likely to interpret that data."

"It will require quite a lot of hard work on our part in thinking it through, but I think we should do it," King added.

He also said that the bank was "clearly not doing enough of it now - which is to give people this feel for how we are likely to react to data."