[ForexNews]

The MPC makes its next policy announcements at noon on Thursday. Analysts expect Bank Rate to be held at 0.5%, and for QE to be held at the current £125bn. However, MPC will most likely make it clear that its assessment of QE is ongoing, and that the policy could be extended if the economy does not recover as the MPC expects. As such, analysts expect what might be called a 'soft halt' (the next decision is whether QE needs to be extended) rather than a 'hard halt' (the next decision is when to tighten policy).

QE is shrouded in uncertainty. It is not clear what quantity of asset purchases is necessary to ensure that the inflation target is hit because the strength of transmission from asset purchases to inflation is unknown. This is why there is so much disagreement about the future of QE, with the latest Reuters poll showing that economists are split 50:50 between those expecting a halt and those expecting an extension. Add to this the well-earned reputation of the MPC for unpredictability and financial markets are understandably nervousness about Thursday's decision.

The expectation of a 'soft halt' rests on a number of factors. The past three months have seen a clear improvement in financial market conditions and a recovery in global economic activity. Also, recent business surveys suggest that the economy is gradually emerging from recession. These will lead the Committee to consider that the large downside risks to growth it saw three months ago have diminished. This is important because in deciding to inject £125bn into the economy the MPC was deliberately trying to be aggressive, risking doing 'too much' rather than 'too little'. The apparent lessening of the tail risk of outright deflation suggests that further loosening may not be appropriate.

This assessment is related to the question of whether the MPC should focus on the 'flow' or the 'stock' of QE, ie whether it should continue with asset purchases until it sees clear effects from the policy, or whether, having decided on the appropriate stock of asset purchases, it should wait to see what the effects are. In the minutes of the July meeting, the MPC made it clear that it saw the stock as the appropriate measure of the policy stance. Given the substantial time lags that are probably involved in transforming BoE asset purchases into stronger nominal demand, the jury is still out on the potency of QE. Monitoring the progress of this 'aggressive' injection for a few more months would seem to be the sensible option.

Although the downside risks may have reduced, MPC's central projection for GDP is expected to be a little weaker than in May, reflecting small downside news on H1 GDP and the effects of the stronger exchange rate. Even so, there may be no material read-across to the inflation projection. The MPC has recently suggested that the economy's potential level of output may be lower than it previously thought. If the Committee were to reduce its estimate of potential GDP then the output gap (and therefore the inflationary outlook) would probably be little changed even with a weaker projection for actual growth.

In view of the uncertain economic outlook, and the problems with assessing the effectiveness of QE, some expect the MPC to proceed with small, piecemeal asset purchases - for example, by announcing extensions of £25bn per month.