Monday, December 05, 2005
Shadow MPC's divisions grow
Posted by David Smith at 09:15 AM
Category: Independently-submitted research

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) 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 December.

On this occasion, five SMPC members voted to hold rates in December, while one voted for a ¼% rate reduction, one voted for a ½% cut, and two members voted for a ¼% increase. The wider background is discussed in more detail in the quarterly SMPC minutes. The next quarterly SMPC meeting will be held at the IEA on Tuesday 17 January, and the minutes from this physical meeting will be released ahead of the February 2006 rate decision.

Comment by Roger Bootle
(Economic Adviser to Deloitte)
Vote: No Change

The case for a reduction in UK rates remains very strong as the weakness of consumer spending drags down overall economic growth. Inflation has already begun to fall back and I expect it to fall further next year. But this is probably not the best month to act. It would make sense to hold back until news arrives about the Christmas trading period. I think rates will be cut in February by ¼%, and if the economy remains weak, will carry on falling to 3½%.

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

Continued high growth of the money supply has been associated with further buoyancy in the London equity market and UK commercial property. Even prime London residential property is said to be having a good time, contrary to the forecasts of a housing crash. The recent spate of bids for UK companies will reinforce these trends. Early 2006 will see at least trend growth in domestic demand, while the world economy continues to expand strongly.

Consumer inflation in autumn 2005 has been lower than I expected, partly because of puzzling movements in such things as airfares, but money supply growth is too high to be consistent with on-target inflation over the medium term. I favour a ¼% rise in base rates.

Comment by Dr Ruth Lea
(Director, Centre for Policy Studies)
Vote: No Change

Labour market remains tight. There is little doubt that economic activity has slowed this year but there are no signs of recession. The labour market remains tight, despite some pick-up in the claimant count, and business in many parts of the country still has difficulties recruiting suitably trained employees. The economy still appears to be running near full capacity. Indeed the relative buoyancy of the labour market, bolstered by the expanding public sector, suggests that the ONS’s output figures could be underestimating economic activity. There is, therefore, no strong case for a cut in interest rates.

Inflationary pressures may be rising… Inflationary pressures are, arguably, ticking up despite the moderation in the CPI inflation rate from 2.5% in September, which was the highest since the series started in 1997, to 2.3% in October. Gas prices, reflecting the country’s vulnerable energy position, will give another boost to the CPI inflation rate in forthcoming months. CPI inflation has picked up in 2005 despite the continuing benign effects of the falling prices for clothing and footwear and household equipment, much of which is imported from the Far East. But import prices are now rising after a period of decline, and these benign effects could soon be reversed.

…but wage settlements remain moderate. Granted, there are few signs that higher inflationary pressures are feeding into higher wage settlements (at least in the private sector) because people still assume that inflationary pressures will be kept under control. It is, therefore, all the more crucial that inflationary pressures are restrained in order to prevent the development of any nascent wage-price spiral.

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

Best to wait and see. The broad money stock continues to grow at above 11% and, with little sign of significant house price falls and the retail slowdown appearing at least temporarily in abeyance (retail sales growth rising to 0.7% in the three months to October, up from 0.4% in the three months to September), the case for a modest rise in rates is strengthening. However, with inflation falling to 2.3% in October, there seems little need to rush, and further weakening of demand in the New Year may yet eventually justify a rate cut, rather than a rise. For now, it seems best to await events.

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

Monetary indicators give conflicting messages, but GDP growth appears to have bottomed out already. Monetary indicators continue to move in opposite directions, making it more and more difficult to arrive at a clear picture of the state of the economy. M0 growth, which closely corresponds to transactions, is a well-known coincident indicator and has fallen from an annual growth rate of 6.1% in August to 5.2% in October. Meanwhile, broad money growth, which has traditionally been a good leading indicator, has stubbornly remained in double digits. Despite the slowdown in sales, it is clear that the services sector has remained resilient to the deceleration in demand. The indications are that GDP growth bottomed out in 2005 Q2 and is on the upswing. A further cut in interest rates would be folly. Indeed, once there is stronger evidence of a pick-up in the economy, the next step in interest rates should be a rise of ¼%. For the moment, there should be no change in rates that might hinder the revival in the economy.

Comment by Professor Patrick Minford
(Cardiff Business School, Cardiff University)
Vote: Cut Rates by ½%

The credibility gained by central banks allows them freedom of action. The situation is one where growth has slowed and inflation is moderate, in spite of the effect of recent oil prices rises. As these latter now recede, inflation will fall back. Consensus forecasts of inflation remain locked on 2% or so. As I have said before, the new environment is one where central banks have credibility for their intentions to keep inflation down; this credibility is the result of a change in popular attitudes to inflation - no one believes that inflation does good any more, so central banks face no political difficulties in keeping it down. The modern central bank therefore has an enviable freedom of action - to move interest rates flexibly to keep real demand or real (velocity-adjusted) money demand growing at the pace of supply.

REPO rate should be cut by ½% to bring growth back on track. Those who do not understand this find reason after reason for not allowing this to happen: there are ‘bubbles’ in relative prices - housing, assets etc - or particular measures of money and credit are ‘misbehaving’. The velocity of the many monetary aggregates needs constantly adjusting for the effects of technological and competitive pressures in financial markets; they cannot be used as if velocity was constant - the evidence is now overwhelming that it is shifting unpredictably. Thus, in short, interest rates should be cut to bring demand growth back on track. I would favour a ½% cut now to signal this in a definite way.

Comment by Professor Gordon Pepper
(Lombard Street Research and Cass Business School)
Vote: Raise Rates by ¼%

Monetary and financial evidence is now strong enough to warrant a rate rise
During recent months, the behaviour of the monetary aggregates has been suggesting that the economy will be more buoyant than indicated by real economy data, and that the risk over the next two years is that inflation will rise rather than fall. In due course, the monetary and real economy indicators should come into line. This can happen either because of a fall in the rate of growth of the monetary aggregates or because of a pick-up in real economy data. Currently, the growth of the monetary aggregates has not fallen, but risen. What is more, the buoyant growth is expected to continue, with mortgage approvals recovering, merger and acquisition (M&A) activity strong, and the public sector net cash requirement high. Further, selective economic data have picked up. There is now sufficient evidence to advocate a ¼% rise in interest rates.

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

Pre-Budget Report. The MPC will be setting rates three days after the Chancellor’s Pre-Budget Report and will almost certainly have received an
HM Treasury briefing on its contents. It seems most unlikely that the Pre-Budget Report will be sufficient on its own to provoke a change in interest rates, although it could have an indirect impact further ahead if it unsettles sterling.

The fact that the UK got through the two peak months of oil price-related pressure on inflation, in September and October, without the sharp upwards leap in inflation observed in some other countries, comes as a relief, even if the main reason was the almost uniquely high proportion of the price of petrol accounted for by taxes in the UK. With the price of crude oil now apparently easing, and this autumn’s high oil prices due to become part of the base for calculating annual inflation by the autumn of 2006, the immediate outlook for inflation appears satisfactory, and the concern is more to do with the outlook for 2007 and 2008 than it is for next year.

Fiscal laxity means monetary policy needs to be tighter than would otherwise have been the case. Britain’s serious fiscal imbalances, double-digit broad money supply growth, and the risk that sterling could be destabilised by higher interest rates overseas, suggest that there is little scope for reducing interest rates until after fiscal policy has been tightened through the expenditure side. This is because there is little reason to believe that the government can tax its way out of the fiscal mess that it has created for itself, once allowance has been made for the adverse second-round effects of higher taxes on aggregate supply. There is also a strong case for not making rate changes at this time of year, until the strength of retail sales over the important Christmas and New Year period is apparent. Overall, the most sensible course appears to be to leave Britain’s official REPO rate unchanged at 4½% on 8 December, and not to think about changing rates until the 9 February 2006 meeting, when a new set of Inflation Report forecasts will be available, and what happened to retail sales over the year end is known.

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

Housing market concerns. Attention continues to focus on the housing market, where the annual inflation rate has stabilised in the range of 2-4%, rather than plunging into negative territory as seemed likely in the late summer. The steep recovery of low-value transactions, which was undoubtedly spurred by the widening of the nil-band of Stamp Duty in March, tells us little about the general condition of the housing market. More illuminating, and a better reflection of household economic prospects, is the shallow improvement in net lending secured on residential property. From a peak in late-2003 of £29.2bn, quarterly net lending hit £21.5bn in Q1 of this year, rising to £22.7bn in 2005 Q2 and £22.1bn in Q3. While lenders are believed to have relaxed mortgage terms even further in an attempt to preserve the flow of business, I do not expect this to result in a decisive rebound in the housing market.

Rising financial difficulties in the personal sector. The November Inflation Report failed to ignite serious inflationary concerns, as expected. The Bank’s strong profile for GDP growth in 2006 and 2007 has attracted widespread scepticism and the notion of an upward wage spiral is equally fanciful, based on the earnings data to hand. Rather, the Bank has been forced to consider, for the first time, that household over-indebtedness is a depressant on consumer spending. The stock of employees with serious financial problems is now thought to approach two million and the cost of unsecured borrowing has recently increased, despite the solitary cut in the REPO rate in August.

Private sector inflation is 1% and real interest rates are high. With the private sector goods and services’ inflation rate settling back to 1% in October, a REPO rate of 4.5% implies a real interest rate in excess of the long-term potential growth rate. Moreover, the latest quarterly CBI survey showed a fall in capacity utilisation in the manufacturing sector. While lowering interest rates may not prevent a further deceleration of the economy, it is unnecessary to maintain real interest rates at such a high level. My vote is for an immediate cut of 25 basis points.

Note to Editors: What is the SMPC?
What is the SMPC?

The Shadow Monetary Policy Committee (SMPC) is a group of independent economists drawn from academia, the City and elsewhere, which meets physically for two hours once a quarter at the Institute for Economic Affairs (IEA) in Westminster, to discuss the state of the international and British economies, monitor the Bank of England’s interest rate decisions, and to make rate recommendations of its own. The inaugural meeting of the SMPC was held in July 1997, and the Committee has met regularly since then. The present note summarises the results of the latest monthly e-mail poll, conducted by the SMPC in conjunction with the Sunday Times newspaper.

SMPC membership

The Secretary of the SMPC is Professor Kent Matthews of Cardiff Business School, Cardiff University, and its present Acting Chairman is David B Smith of Williams de Broë Plc. Other current members of the Committee include: Professor Patrick Minford (Cardiff Business School, Cardiff University), Professor Tim Congdon (Founder, Lombard Street Research), Professor Gordon Pepper (Lombard Street Research and Cass Business School), Professor Anne Sibert (Birkbeck College), Dr Peter Warburton (Economic Perspectives Ltd), Professor Roger Bootle (Deloitte and Capital Economics Ltd), John Greenwood (AMVESCAP), Professor Peter Spencer (University of York), Dr Andrew Lilico (Europe Economics), and Dr Ruth Lea (Director, Centre for Policy Studies). Professor Philip Booth (Cass Business School and IEA) is technically a non-voting IEA observer. However, he is awarded a vote on occasion to ensure that exactly nine votes are cast.


Interesting comment from Professor Patrick Minford above who suggests an immediate 0.5% drop in interest rates.

"As I have said before, the new environment is one where central banks have credibility for their intentions to keep inflation down; this credibility is the result of a change in popular attitudes to inflation - no one believes that inflation does good any more, so central banks face no political difficulties in keeping it down."


Sounds rather naive to me, and I'm sure Jean-Claude Trichet (ECB president) would agree. Just look at the grief he as had.

Interesting too that he offers growth targeting as a means of justification for a interest rate drop. Mervyn King has countless times reinforced the banks mandate of interest rate targeting:

"I think a number of people in the last six months have been talking as if the [interest rate setting] MPC targets demand, or even more oddly, retail sales and consumer spending. We are not. We are trying to target inflation. We have an inflation target."

Good old Mervyn stands true. God bless him...

Patrick Minford is a professor at Cardiff Business School. As such he represents a clear vested interest in business growth which appears to a clouded his mind to any upside inflation risk (or even the basic inflation targeting role of the MPC).

You wouldn't ask Halifax if we should drop interest rates and still expect an unbiased answer, would you? They would only be too happy to see a 0.5% drop, regardless of any wider negative effect.



Posted by: Werewolves at December 5, 2005 01:08 PM

Well said, Werewolves.

Peter Warburton’s reasoning was equally beside the point - focusing on house prices, personal sector indebtedness and the mysterious ‘private sector inflation’.

We’ll have a good idea by next March what the state of consumer spending and wage growth really is and their likely impact on inflation. I’ll be very surprised if the talk isn’t of interest rate rises by then.

Posted by: Sandid at December 6, 2005 11:23 AM