Sunday, June 05, 2005
Shadow MPC votes for no change in rates
Posted by David Smith at 10:08 AM
Category: Independently-submitted research

The results of the latest Shadow Monetary Policy Committee (SMPC) monthly e-mail poll for the Sunday Times are set out below. Members of the Institute for Economic Affairs’ (IEA’s) SMPC speak in a personal capacity and their contributions are arranged in alphabetical order. The rate recommendations are with respect to the MPC rate decision to be announced on Thursday 9 June. On this occasion, seven SMPC members voted to hold rates in June, while one voted for a ¼% rate hike and one for a ¼% cut.

Wider background

The wider economic background is discussed in more detail in the regular quarterly SMPC minutes. The next quarterly SMPC meeting will be held at the IEA in Westminster on Tuesday 19 July. The minutes from this quarterly physical meeting will be released about a week afterwards.

Comment by Roger Bootle
(Economic Adviser to Deloitte)

Vote: No Change
MPC expected to cut rates in August, with further reductions to follow
The evidence is now building up strongly in favour of lower rates. Consumer spending is very weak and neither exports nor corporate investment seem able to compensate. Meanwhile, the contribution of the public sector seems set to fade. Nor do inflationary pressures look likely to be a problem. Nevertheless, while ambiguity remains about the housing market, I think it will be right to wait a little longer. But I expect the Bank to cut interest rates in the next Inflation Report month, ie August. And once the Bank starts cutting rates, it will not hang about. I reckon that base rates could be down to 3.5% next year.

Comment by Professor Tim Congdon
(Lombard Street Research)

Vote: No Change
Mixed messages from recent indicators suggest leaving rates steady for the time being
Key pointers to the UK economy give different messages at present. Money supply growth remains high, but usually reliable leading indicators - such as housing market variables and the results of business surveys - are weak. The Monetary Policy Committee (MPC) has been right to keep base rates stable since last August and perhaps it can leave them unchanged for another month or two, but I continue to believe that higher interest rates will be needed to quell unduly high growth rate of credit and money.

Comment by John Greenwood
(Chief Economist, AMVESCAP)

Vote: No Change
UK economy has cooled in recent months, but there are still signs of underlying strength
The UK economy has softened distinctly in recent months. The cooling of activity has spread from the housing sector and retail sales to consumer credit and business investment. Not surprisingly, all these sectors are all acutely sensitive to the cost of funds. However, there remain signs of strength elsewhere in the UK economy that warrant the continuation of monetary restraint. The Conference Board’s Lead Indicator, which includes new order volume, expected output volume, house-building starts, a share price index and other leading series hit an all-time high in March. The labour market remains tight, displaying buoyant wage growth with especially strong increases in the public sector, and unemployment remaining at 2.7% in April - only just off its record low of 2.6% in February. Consumer confidence as measured by the GfK index in May was higher than in any month except January last year, while the MORI index of economic optimism in March was higher than all months since April 2002. In addition, government expenditure continues to expand vigorously (6.7% in the year to April). The UK trade and current account deficits are evidence of strong domestic demand. Although inflation is currently below target (at 1.9% in April on the CPI measure), it could rise further as sterling falls. Manufacturing output prices were up 3.2% in April. Moreover, sterling M4 growth remains uncomfortably rapid (at 10.4% in the twelve months to April). It is no longer so clear that a rate hike will be needed later in the year, but no action is required at present.

Comment by Dr Andrew Lilico (Europe Economics)
Vote: Raise by ¼%
Rapid monetary growth justifies higher rates
Despite some modest recent slowing, particularly in narrow money measures, monetary growth continues to be stronger than is compatible with the inflation target over the medium-term. GDP growth, though modestly slower in Q1, continues to be fairly near-trend. The housing market, though slowing all the time, has still not started to fall very significantly. Oil prices, though down from their peaks, show little signs of significant falls. Inflation is near-target, so with monetary growth too rapid and countervailing factors not in play, we should tighten slightly to dampen the excess monetary growth.

Comment by Professor Kent Matthews
(Cardiff Business School, Cardiff University)

Vote: No Change
Weak economy, but inflation on target, suggest rates should be left alone
The time for raising interest rates has very likely passed. The conflict of signals from the economy warrants a no-action policy for the time being. Monetary trends remain uncomfortably out of step with an inflation target of 2% but retail spending, the housing market, and business surveys all point to a slowing down in the economy. It would seem that the past hikes in interest rates have started to have some effect. Expectations about future tax rises may also be playing a part in taking the froth out of household credit demand and consumer spending. With inflation on target and expectations of inflation remaining at around this level, unless something precipitous happens to the housing market, there is no argument for lowering rates. With the economy now showing signs of cooling, there is no argument for raising rates.

Comment by Professor Patrick Minford
(Cardiff Business School, Cardiff University)

Vote: Cut Rates by ¼%
Only buoyant demand component is government spending
The figures continue to argue for a cut in interest rates. The first quarter growth has been cut to 0.5%. Inflation is (just) below the target rate, with the ambient indicators suggesting a slowdown. Retail sales are weak, and first quarter household expenditure volume was estimated to be 0.3% up. Fixed capital formation showed no volume growth - basically only public spending was buoyant and that now has to slow because of budget difficulties.
Cutting lending costs now would stop slowdown becoming entrenched
On the monetary front, M0 has slowed to below 5%, confirming the weak spending side. M4 is growing at just over 10% but is quite hard to interpret. The housing market is in a wait-and-see situation. A cut in interest rates would help to stabilise the growth of spending around a feasible 2-2.5% growth rate. The risk in delaying the cut is that the slowdown could become entrenched, and require much larger cuts later.

Comment by Professor Anne Sibert
(Birkbeck College)

Vote: No Change
Sub-trend growth means UK output gap will widen
The growth of UK nominal and real economic activity is slowing steadily and markedly. On 23 May, the OECD once again revised downwards its forecast for 2005 real GDP growth, this time to 2.4%, with growth in 2006 also estimated at 2.4%. The UK Treasury estimates the growth rate of potential output to be 2.75% per annum for 2005 and 2006, falling to 2.5% in 2007. This means that the output gap (which is probably close to zero) is likely to widen in the next two to three years, putting downward pressure on inflation.
‘No’ votes to EU Constitution may lead to stronger sterling
The French electorate’s rejection of the Treaty and the prospect of future rejections in the Netherlands and elsewhere suggest that the effective sterling exchange is more likely to strengthen than to weaken. Oil prices are coming down with a weakening of the world economy.

Summer cuts?
Should these developments persist through the summer, a cut in rates will be necessary; for now, the interest rate should be unchanged.

Comment by David B Smith
(Chief Economist, Williams de Broë plc)

Vote: No Change
Financial markets are now discounting a near-term rate increase
The British economy appears to have taken on a mild stagflationary bias, but this is only to be expected when the government is pursuing tax-and-spend policies, and it is hard to know what the MPC can do about it. There appears to be a growing view that the next move in REPO rate will be downwards. However, excessive monetary ease in a supply-constrained economy leads to inflation, not growth. Broad money supply growth, at 10.5% in the year to April, remains a serious concern; lending excluding the effects of securitisations has risen by 11.9%, and CPI inflation is nudging up against its central 2% target, having been 1.9% in March and April. The ‘old’ sterling index was 103.9 (1990=100) on 31 May, which is a high neutral level, but not one where a rate cut seems especially needed. Rates seem likely to remain on hold until August, when a new Inflation Report will be available, and the MPC can decide in the light of conditions at the time. As far as 9 June is concerned, a policy of letting sleeping dogs lie seems as good as any other, particularly if recent political developments on the Continent cause capital to flow out of the Euro-zone into sterling.

Comment by Peter J Warburton
(Director, Economic Perspectives Ltd)

Vote: No Change
Private sector inflation remains subdued
The March and April consumer price inflation figures, which took the CPI rate to 1.9%, do not represent a worrying turn of events and it would be a mistake for the MPC to react to them. The rate of private sector inflation, of both the goods and services components of the retail price index, has remained less than 1% for most of the past year or so. Erratic items, including energy costs and seasonal foods, continue to provide the bulk of the volatility to the headline data. The weakness of retail pricing is particularly obvious within the retail sales data. While the housing market continues to send out ambiguous signals, it is clear that this house-buying season bears no resemblance to last year’s. Within another few months, it should be clear another REPO rate rise is not justified. The MPC can afford to be patient.


Are we there yet?

Alan Greenspan said the following this week about ‘neutral’ interest rates: “"We will probably know it when we are there, because we will observe a certain degree of balance that we have not perceived before, which would suggest to us that we're somewhere very close to what that rate is."

Our own Merv-the-no-swerve must be wondering if we’ve reached a certain degree of balance or, rather like an unstable tightrope walker, we’re at the mid point in a major wobble.

My guess is that US interest rates are going to keep going up for much of this year. That will make the pound fall against the dollar and inflation rise. If the MPC were to cut interest rates the inflationary effect could be much worse.

The MPC has been lucky so far because the euro has also fallen against the dollar - for political reasons rather than economic ones. But the euro could easily recover for political reasons too. That would put the spotlight on the UK high-wire act. A rate cut at this stage would appear as a very desperate act. I hope it’s not needed but if the MPC has to cut rates, look out below.

Posted by: David Sandiford at June 11, 2005 06:08 AM

The euro stands no chance of recovery through "£political reasons" - the only thing that could strengthen it would be if wispers about the German economy prove to be true (or if the Italians left!).

But agree that a rate cut would probably be counter productive since the effects it would have on confidence would far outweigh any positive effects in the balance sheets.

Posted by: Giles at June 12, 2005 11:52 AM