The "shadow" Bank of England monetary policy committee (MPC), which meets under the auspices of the Institute of Economic Affairs each month, offers its deliberations on interest rates. Here are its latest conclusions.

The results of the latest Shadow Monetary Policy Committee (SMPC) 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 Monetary Policy Committee (MPC) rate decision to be announced on Thursday 8 September.

On this occasion, six SMPC members voted to hold rates in September, while two voted for a further ¼% rate reduction. Only one SMPC member voted for a ¼% increase in September. However, four other SMPC members regarded the August rate cut as an error, which would have to be reversed sooner rather than later. The wider economic background is discussed in more detail in the quarterly SMPC minutes. The next quarterly SMPC meeting will be held at the IEA on Tuesday 25 October, and 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

The MPC was absolutely right to cut rates in August. But this is a month to do nothing. It would now be sensible to wait until November, when there will be more information available and the Bank has to revisit its forecast for the Inflation Report. I was unconvinced by the Bank’s reasoning in its last Report, and in particular by the emphasis it paced on the boost to demand from higher equity prices. I suspect that the evidence will favour another cut in rates in November.

The fact that the Governor voted against the decision at the last meeting does not matter. Indeed, it may serve to strengthen the credibility of the MPC. But if the Governor continues to be in a minority for many months the opposite would be true. Indeed, the Governor’s own position as he sought to defend the MPC’s policy in public and at the House of Commons Treasury committee, would be extremely difficult.

Comment by Professor Tim Congdon
(Lombard Street Research)
Vote: Raise by ¼%

Higher energy costs have disturbed relationships between money and the real economy.

The big rises in energy prices have disturbed the relationships between money, on the one hand, and economic activity and inflation, on the other. A large shift in spending power from oil consumers to oil producers has occurred and is continuing, and that has hit consumer demand in the industrial nations, including the UK. However, the world economy is enjoying a strong 2005. Rising energy prices will push the increase in the consumer price index to 2¾% in September, almost to the 3% level at which an open letter of explanation from the Bank of England to the Chancellor is needed.

Rapid UK monetary growth has had its usual effects.

Rapid money growth in the UK has been associated - as usual - with cash-rich corporate balance sheets, ample liquidity in the financial system and rising asset prices. The Bank of England was wrong to cut interest rates and should restore the 4¾% figure as soon as the economic news (and public relations) makes it convenient.

Comment by John Greenwood
(Chief Economist, AMVESCAP)
Vote: No Change

UK economic activity close to trend.

Since the MPC’s regrettable decision to cut rates by 0.25% to 4.5% on 4 August, the limited amount of new data released suggests that the economy has continued at or near trend growth, and property prices have continued to show signs of stabilising, rather than weakening. Although the BRC survey for July and the CBI Distributive trades report for August continued to suggest weakness in the retail sector, broader service sector indicators such as the PMI services survey for July were firmer. Data for manufacturing, industrial production, and business investment have held their levels or improved slightly in recent months. June data for the labour market showed no further weakening. These trends were reflected in the upward revision of second quarter GDP to 0.5% quarter-on-quarter, or 2.0% annualised and 1.8% year-on-year.

Money and credit.

In the monetary area sterling M4 has continued to grow at double-digit rates (11.5% year-on-year in July), as has M4 lending (10.7% year-on-year in July). Business lending has been picking up, offsetting a slowdown in the personal sector. For example, M4 lending to non-financial companies has been accelerating (+14.9% in the year to July), while net lending to individuals in July (£7.7bn) has shown a marginally weaker trend, with net lending secured on dwellings (£6.5bn) weaker than the previous six-month average. However, the number of loans approved for house purchase (97,000 in July) has been creeping upwards.

Inflation.

CPI inflation data for July showed a month-on-month increase of just 0.1%, but the year-on-year figure jumped to 2.3%, due to a decline in the index in July last year. Industrial input prices have risen strongly (+13.4% year-on-year in July), but output prices have been contained by intense competition and margin compression (+3.0% in July).

Why the UK REPO rate should be held.

In summary, with the economy still growing close to trend rates, and cost pressures strong, there is no margin for further easing. Rapid money growth rates imply a risk that demand could strengthen again, reigniting inflation. This leads to the conclusion that rates should not be cut, but held at the current level.

Comment by Dr Andrew Lilico (Europe Economics)
Vote: No Change

Real economy may warrant lower rates, but inflation does not.

As one had feared since late last year, the situation we now face is that real economy factors speak for a fall in rates, but inflation is above target and rising. Broad money growth continues to suggest that inflation will rise in the medium term, and narrow money growth is, if anything, accelerating. Oil prices seem very unlikely to fall substantially soon, and may even rise. Retail sales data is weak, though perhaps not so weak as had been thought, and overall growth is modest.

MPC should have raised rates earlier.

By refusing to raise rates previously, the MPC has now restricted its room to manoeuvre, and reduced its capacity to send signals to the market to speeches and the number of votes either way in MPC meetings. Time will tell how serious a limitation this will prove to be. In terms of interest rates, however, it should definitely be holding at this stage.

Comment by Professor Kent Matthews
(Cardiff Business School, Cardiff University)
Vote: No Change

August rate cut was premature…

The Maradona theory of interest rates suggests that had the MPC kept interest rates on hold as the majority of the SMPC had suggested at its last poll, the economy would have slowed down on target without any need to change monetary policy. The result would have been that interest rates could have been lowered at a later date and kept lower for longer. With M4 growth still in double digits, the cut in rates could at best be described as premature; and at worst be described as panic.

…and should be reversed sooner rather than later

Admittedly, house price inflation has declined markedly and the economy has slowed, as it must do to be in line with capacity output. However, narrow money (M0), which is a good coincident indicator, suggests that nominal GDP growth is likely to be in the order of 4-4.5% which still leaves no room for inflation to fall below 2%. Unless broad money growth (a better leading indicator) shows signs of abating in the next few months, the cut in rates will have to be reversed sooner rather than later.

Comment by Professor Patrick Minford
(Cardiff Business School, Cardiff University)
Vote: Cut Rates by ¼%

World economy is not awash with liquidity.

The case for higher interest rates is supposed to be related to the growth in the money supply. We are told by many of those on that side of the argument that ‘the world is awash with money’, and the UK in particular. Along with this argument tends to go the view that stock markets are being ‘fuelled by easy money’, that ‘bubbles are proliferating’ in Internet stocks, and so forth. Yet the basis for these statements is questionable in the extreme. The money supply figures around the world show quite moderate growth: broad money in the US is up 5% on a year ago and narrow money is up 1.1%, in the UK they are respectively 11.5% and 4.9%; in the euro area 7.5% and 10.5%. These numbers are not all extremely small, though some are. But they are hardly the stuff of ‘excess’.

Some are perhaps worrying to those who are persuaded that balance sheet engineering does not create gyrations and distortions in the broad money numbers particularly. But that is all. Frankly, the instabilities of broad money in increasingly deregulated money markets are now so well documented that it would require quite extreme growth rates - over 20%, or negative perhaps - to convince one that something remarkable was going on.

High commodity prices are only a relative price shock.

In particular, there is no indicator of underlying inflation that supports the idea of a world ‘awash with cheap money’ or anything approaching it. Consumer prices are growing at between 1% and 3%, and wages at between 2% and 4.5% across major OECD countries - ignoring still deflationist Japan. Producer prices are growing a bit faster at between 1% and 5%. This reflects the effect of rising commodity prices, which are up some 7-10%, depending on the currency. Over the past year, oil in particular has risen some 40% and is now trading at US$70 a barrel or so.

We are witnessing an old-fashioned shortage of some commodities as growth enters a middle stage of the world business cycle. Commodities have been the Cinderella of the world economy for so long that a decent recovery in their relative prices is overdue; it is all too likely to lead to a surge in investment to raise production capacity, followed by another price slump as capacity peaks and growth slows. The point, however, is that whatever happens to them, their behaviour is that of a relative price and not a harbinger of general inflation. If their relative prices continue to rise then the terms of trade will have shifted between the raw-material-consuming and producing countries, and the former consumers will have to tighten their belts, as they are already doing.

Success of inflation targets.

The reason why this world upswing is free of inflation, unlike so many of its post-war predecessors, is easy to see: monetary policy makers across the world have vowed to keep inflation at around 2%. As they have the tools to do so - and such a policy is now regarded by their electorates as the obviously correct course - there is no reason for any individual, firm or union to expect that inflation will systematically exceed such a target. The success of this ‘inflation targeting’ has been surprising to many; but its success is logical and cannot be denied. The most important ingredient, in retrospect, was the conversion of electorates to the idea that the job of governments was not to use monetary policy to create jobs but rather to control prices. Sadly, some electorates, notably in the Euro-zone, have yet to understand that to create jobs governments must deregulate labour and product markets; that too will come but it still needs time, education and a few more brave governments.

Scope for further rate cuts.

The implication for UK interest rates is that they can be flexibly lowered to counter the slowdown now in progress. The Bank of England would therefore be wise to continue to lower them in the months to come so as to pre-empt this slowdown. They can move towards a levelling off when growth has settled around 2.5% again. But that is not yet in evidence.

Comment by Professor Gordon Pepper
(Lombard Street Research and Cass Business School)
Vote: No Change

Seeds of inflation.

The seeds of inflation are sown a year or more before the inflation materialises. In every economic upswing during the last four decades or so, the knights of British industry and the CBI have strongly disagreed with the first rises in interest rates that, in due course, have proved to be too little, too late.
Industrialists have a vested interest in low interest rates and their views should be ignored.

August rate cut was an error.

Last month’s reduction in rates was mistaken. If the Governor of the Bank has to write a letter to the Chancellor explaining why inflation has risen, he will at least be able to say that neither he nor the deputy governors argued that rates should be cut. They were out voted.

Having reduced rates, the MPC would lose credibility if it were to raise them again straight away. Excess money is currently being spent on assets rather than on goods and services. In due course the consequential increase in wealth will encourage additional expenditure on goods and services. As Tim Congdon has recently argued, ignoring wealth effects was an important reason why the 364 economists who predicted serious recession or depression after the 1981 budget were so wrong. The current consensus that economic growth will be sluggish is likely to be wrong for similar reasons this time. Evidence of economic recovery should become available before long. The best course of action at the moment is probably to wait until the evidence becomes available, and to raise rates then by, perhaps, two ¼ points in quick succession.

Comment by David B Smith
(Chief Economist, Williams de Broë plc)
Vote: No Change

MPC risks repeating policy errors of the 1970s.

It is fortunate that ¼% changes in the REPO rate have only a minimal impact on the British economy, because the 4 August base rate cut looks increasingly like an error. The July upturns in most measures of annual consumer and producer price inflation were undoubtedly oil price-related. However, the price of oil has risen further since then, and there is a risk that the MPC is repeating the monetary policy mistakes of the 1970s, and endangering longer-term inflation discipline, in its attempts to offset the transitory contractionary effects of a relative price shock to energy costs.

Monetary laxity risks reinforcing the damaging effects of fiscal fecklessness
Another concern, familiar to anyone who experienced the 1970s, is that people might come to believe that the MPC has a bias towards a lax monetary stance because it is attempting to keep the economy growing beyond its natural rate, in order to boost tax receipts. It may be significant in this context that the professional bank insiders, apart from Mr Bean, voted against a rate cut in August, while the external members were unanimously in favour. As far as September is concerned, there is no case whatsoever for a further reduction in interest rates. Indeed, there is room for debate as to whether the August reduction should be reversed at the first convenient opportunity. More generally, any further rate reductions are likely to prove dangerous and unsustainable without a package of measures to reduce the excessive growth of public spending. Adding monetary laxity to fiscal irresponsibility is a recipe for ingrained stagflation, and high structural unemployment on Continental lines, not a successful internationally competitive economy.

Comment by Peter J Warburton
(Director, Economic Perspectives Ltd)
Vote: Cut Rates by ¼%

Private sector inflation still only 1%.

Despite a slight increase in the inflation contribution of private sector goods and services over the past six months, this remains close to an annual rate of 1% and well below the threshold of concern for the MPC. An abatement of the ‘external’ (eg energy), ‘administered’ (eg fuel, alcohol and tobacco via indirect taxes) and interest-rate pressures on headline inflation has begun and should deliver steady reductions in official inflation measures for the remainder of the year.

Private demand remains weak, despite improved net exports.

Meanwhile, the publication of the detail behind the second quarter GDP data has revealed that real domestic private expenditure fell in the quarter, leaving domestic spending momentum at its weakest for 10 years. The improvement in net exports that rescued some growth in GDP looks vulnerable to revision after the admission that the ‘Missing Trader’ fraud continues to cloud the external picture. The MPC would do well to disregard the external contribution to GDP for the time being and to concentrate on domestic trends. Here, the stagnation of business investment by the most dynamic private services sectors, and the sharp fall in stockbuilding, suggest that consumer weakness has spread into the business sector.

Cut rates again.

Arguably, there is less urgency for the second cut in REPO rates than for the first, which duly occurred, but there is increasing evidence that the economic tide has turned. My vote is for another ¼ point REPO rate cut at the September MPC meeting.