Sunday, January 09, 2005
Bank stalwarts did well, can they keep it up?
Posted by David Smith at 10:00 AM
Category: David Smith's other articles

THIS year the Bank of England’s monetary policy committee (MPC) will clock up 100 meetings since chancellor Gordon Brown granted it the power to set interest rates back in 1997.

So far there have been 91 such meetings in a long and generally successful run, in which the Bank has won some deserved plaudits. The governor and his colleagues always shrug these off, not just because they are a naturally modest bunch but because they also know pride is all too often followed by a fall.

How do the results of all these monthly gatherings divide? Most of the time nothing happens, despite the build-up and the moment of drama at noon on a Thursday.

Of the 91 meetings, two-thirds, or 62, resulted in no change in rates. Of the others, the split between rate rises and cuts was pretty even. There have been 14 increases and 15 reductions. There was also one cut outside the schedule, in September 2001, the Bank’s emergency response to the September 11 attacks.

Has the MPC, as some believe, become less activist and more predictable during its seven-and-a-half years of independence? The first meeting of the newly independent body was in June 1997. In the first three years it changed rates 16 times, nearly once every two meetings. In the next three, from June 2000 to June 2003, rates were varied only eight times, including the emergency 9/11 cut. Circumstances change, but it does seem the Bank has become less trigger-happy.

Rates have also generally got lower. The Bank started independent life with the base rate (the “repo” rate to be strictly accurate) at 6.25%, the chancellor having raised it by a quarter of a point in May 1997 before handing over the reins. A year later it hit 7.5%, the highest since independence. The repo rate has since been as low as 3.5%. If the present 4.75% is the peak, it will continue the process in which successive peaks have fallen.

But is it the peak? As the Bank approaches its 92nd MPC meeting this week, the question is a live one. The “shadow” monetary policy committee, a group of nine economists operating under the auspices of the Institute of Economic Affairs, captures the dilemma.

Six members of the shadow MPC vote for no change in rates, which is the outcome the City expects. But two vote for a rise of a quarter-point and one for a similar reduction. Even allowing for the old joke that if you put enough economists in a room every possible opinion is guaranteed, all three positions have something to be said for them.

Holding rates looks sensible in the face of uncertainty and reports from several retailers that Christmas results failed to cheer. This is also traditionally a time when the data take a while to settle down. Purchasing managers’ surveys for manufacturing and services, out last week, were unusually weak.

A cut in rates would be a direct response to the cooling housing market. November’s mortgage approvals, 77,000, were the lowest since September 1995 — before the boom began.

Some say that whatever the Bank does it will be too late to prevent a sharp fall in house prices. Others argue that the MPC could prevent a housing-market rout if it gets its rate-cutting skates on.

How seriously should we take the slump in approvals? It is a volatile measure and has fallen sharply before, most recently at the start of the Iraq war. It may have been marginally affected by new Financial Services Authority rules on mortgage lending dating from October 31. Most of all, though, it does not on its own argue for a rate cut, particularly when Halifax says prices rose 1.1% last month.

The Bank has been desperate to avoid getting caught in a position where it is forced to cut rates because of the housing market. Hence its strenuous efforts to demonstrate, not very convincingly, that consumer spending would not be much affected by a drop in prices.

Its problem, as Stephen Lewis of Monument Research points out, is that the public verdict on the Bank “depends much more on whether it manages to head off a housing-market meltdown than on its success in keeping consumer price inflation close to the target”.

Its other problem, say some economists, is that the consumer price index — well behaved so far — is due for a bout of disobedience.

Tim Congdon of Lombard Street Research is one member of the shadow MPC who thinks rates should rise; Gordon Pepper is another. The money supply is rising by about 9% and this, they say, is incompatible with 2% inflation.

A new analysis by Lombard Street also gives several other reasons to be worried about inflation.Factory-gate inflation, even leaving out volatile food and energy prices, is at its highest rate for eight years. Firms are facing higher prices for raw material and fuel. Car- makers and others are grappling with big steel price rises. In the past these so-called pipeline inflationary pressures have fed through into general inflation.

Britain has been a big beneficiary of falling import prices and falling goods prices in the stores. But this effect is diminishing. Wage pressures are gradually increasing due to the tightness of the labour market, the Lombard analysis shows.

We should not get too worried. Lombard expects inflation to rise only a little above the 2% target. Sterling commodity prices overall are no higher than a year ago. Factory-gate inflation is no longer a reliable harbinger of general inflation.

But while the MPC should not be increasing rates, it is premature to talk of cuts. The Bank should sit on its hands for some time. And that is never very comfortable.

PS: What does economics have to say about the public response to the Indian Ocean tsunami, with UK donations exceeding £100m? Some say it is not that generous when set against other economic magnitudes. Consumer spending is more than £700 billion a year and we have just been through a big burst of it. The donations add up to less than 0.02% of annual spending. The real point, however, is that they have been large compared with other appeals.

Why do people give? Economists have long struggled over that question. The rational economic man of the textbooks doesn’t do anything for purely altruistic reasons, so the challenge has been to find “selfish” reasons for giving.

Giving, for example, generates a warm glow similar to other types of consumption. There is also a demonstration effect. For several days after the disaster the scale of donations was one of the key elements of the story. People gave to be part of that story, just as they may have mourned more publicly after the death of Princess Diana in 1997, because others were.

Just as governments can “crowd out” charitable giving by spending on taxpayers’ behalf, so donations may have been “crowded in” by the government’s slow initial response. Making donations tax-deductible, as in America, brings in more for charities than Britain’s Gift Aid scheme.

The motivations of business are more easily defined. Companies gain good publicity, their customers like it, and there is a good chance of securing the loyalty of future customers among the recipients of aid.

Is this too cynical? Probably. This disaster brought in donors who would not normally give to charities such as Oxfam and Christian Aid. That was partly because of the nature of the event but also because such charities sometimes seem to spend more time in political campaigning than relieving poverty. There’s a lesson here.

From The Sunday Times, January 9 2005