November interest rate cut on the cards
Interest rates could be cut as early as November as the group of economists responsible for setting rates grows ever more concerned about the economic downturn.
Despite fears of a recession before the year is out, the Bank of England’s Monetary Policy Committee (MPC) has resisted cutting rates since April because of rising inflation. The Consumer Price Index – the official measure of rising prices – hit 4.4% in July, well above its 2% target, and is expected to continue to rise going forward as a result of higher fuel and food prices.
The minutes from the August MPC meeting show that the majority of members continue to sit on the fence, content to see how inflation and the economy pan out before altering interest rates. Although they expect inflation to increase and the economy to weaken over the coming months, the hope is a slower British economy will bring down inflation without the need for interest rate movement at the current time.
However, the minutes also hint that concerns over inflation has lessened since July, with anxiety over the economy more at the forefront of MPC member’s minds.
For example, at the August meeting MPC members noted that the risk of inflation increasing has eased slightly since July, when taking the fall in oil prices into account.
In addition, members discussed the fact that “credit conditions had tightened further”, and the labour market had eased. They also looked at conditions in the mortgage market, pointing out that interest rates on loans had risen and criteria had tightened.
Peter Newland, an economist at Lehman Brothers, says despite the continuing concern over inflation, the minutes suggest MPC members are now placing more weight on economic issues.
“The minutes gave an impression of a slightly more sanguine view of inflation pressures, with more weight given to the sharp pull-back in oil and commodity prices than the upside [inflation] surprise in July,” says Newland.
He adds: “We continue to judge that the MPC’s inflation concerns will ease further in coming months, as oil prices stabilise and inflation nears its peak, and that a further weakening of activity will mitigate worries of second-round effects, leading to the first of a string of rate cuts in November.”
However Ben Read, a senior economist at the Centre for Business Research, says the debate over whether inflation or the economy should take priority shows no sign of dying down – making a cut before the end of the year unlikely.
He says: "For the first time in a number of months there was acknowledgement of a more mixed near-term inflation outlook... [The MPC considers] the upside risk to inflation has probably eased. However, there were few signs of an imminent rate cut as the committee still considers the overall risks to inflation to be on the upside, and there is clearly substantial unease over sending out the message that the MPC is more concerned about sustaining output growth than tackling inflation."
Read forecasts that the argument for interest rate cuts will grow stronger over the coming months but the majority of MPC members will still prefer to take a wait-and-see attitude.
"Our central view remains that we will see the first rate cut in early 2009, with an outside chance of a cut before Christmas if it becomes clear that inflation is starting to turn the corner," he adds.
Despite a slight shift in concern, MPC members continue to be split three-ways over the future of interest rates, with one member voting for an increase, another for a cut and the majority for a freeze.
Tim Besley, the member who voted for a 0.25% increase in rates, believes that rising inflation must be tackled immediately by raising rates. In contrast, David Blanchflower attempted to convince his fellow MPC members that the economic downturn warrants a cut in rates. He believes the risk of recession is greater than that of rising inflation.
Monetary Policy Committee
A committee designated by the Bank of England to regulate interest rates for the UK. The MPC attempts to keep the economy stable, and maintain the inflation target set by the government and aims to set rates with a view to keeping inflation at a certain level, and avoiding deflation. The MPC meets on the first Thursday of each month and discusses a variety of economics issues and constitutes nine members: the governor, the two deputy governors, the Bank’s chief economist, the executive director for markets and four external members appointed directly by the Chancellor.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).