Double-dip fears keep rates at 0.5%
Economists were today predicting more quantitative easing could soon be on the cards as fears of a double-dip recession gather pace.
The Monetary Policy Committee held interest rates at their record low of 0.5% for an 18th consecutive month and also kept its quantitative easing programme at £200 billion as it stays in 'wait and see' mode with inflation remaining stubbornly high and economic growth hitting a stumbling block.
Graeme Leach, chief economist at the Institute of Directors, said: "The Bank of England has held fire for another month, but we think the quantitative easing gun is about to be re-loaded and the order to shoot given.
"Whilst above-target inflation has stopped the MPC pulling the trigger on a further extension in quantitative easing this month, the economic threat from weak money supply growth looms ever larger."
Duncan Higgins, senior analyst at Caxton FX, added: "The minutes in a fortnight's time may signal increased arguments in favour of extending quantitative easing. Amid signs that the UK economic recovery is slowing and with the spending cuts soon to start biting, the committee members may feel that the conditions for further monetary stimulus are getting closer."
Last week, fresh figures showed that growth in the UK's manufacturing sector dropped to a nine-month low in August with nervousness over the impact of forthcoming government cuts keeping the sector on tenterhooks.
Meanwhile, the purchasing managers' index for the construction sector fell to a six-month low after a drop in the number of new homes being built. The dominant service sector is also experiencing problems with growth slumping to a 16-month low in August.
Although the figures for all indices remain above the 50 mark which marks growth Markit said that the three surveys taken together suggests that economic growth will have slowed to 0.5% in the third quarter, down from the better-than-expected 1.2% of the previous quarter.
The housing market is also slowing significantly with recent surveys registering further falls in the annual rate of property price growth.
In contrast, inflation remains above the 3% mark and is likely to rise further. Barclays Capital economists believe it could have lifted to 3.2% in August while the planned rise in VAT to 20% in January will push it higher still.
However, dissent is growing among the nine members of the Monetary Policy Committee. Andrew Sentance has voted for a 25 basis point increase in each of the past three months.
Joshua Raymond, market strategist at City Index said: "Most of the market is expecting no movement in rates until next year at the earliest with traders betting that any change in the central banks stance likely to come in the form of additional stimulus rather, than monetary tightening, particularly with the UK recovery far from certain."
Invented by a Frenchman in 1954 and ironically introduced in the UK on 1 April 1973, VAT is an indirect tax levied on the value added in the production of goods and services, from primary production to final consumption and is paid by the buyer. Its levying is complex, with a number of exemptions and exclusions. For example, in the UK, VAT is payable on chocolate-covered biscuits, but not on chocolate-covered cakes and the non-VAT status of McVitie’s Jaffa Cakes was challenged in a UK court case to determine whether Jaffa Cake was a cake or a biscuit. The judge ruled that the Jaffa Cake is a cake, McVitie’s won the case and VAT is not paid on Jaffa Cakes in the UK.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
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).