Monday, January 09, 2006
Three members of the shadow MPC vote for rate cut
Posted by David Smith at 05:00 PM
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 12 January. On this occasion, six SMPC members voted to hold rates in January, while two voted for a ¼% rate reduction, and one voted for a ½% cut. The preponderance of holds provides a slightly misleading picture of consensus, however. This is because many SMPC members thought that it was inappropriate to alter rates in January, as a result of uncertainties about the strength of retail sales over the important Christmas and New Year periods, but could see a case for a more active approach in February, when the MPC will also have a new set of Inflation Report forecasts available.

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 17 January, and the minutes from this physical meeting will be released ahead of the 9 February rate decision.

Comment by Professor Tim Congdon
(Founder, Lombard Street Research)
Vote: No change

A fascinating situation is developing, which will make 2006 a test of rival macroeconomic theories. The majority view remains that the check to consumer spending in 2005 will lead to a wider slowdown in the economy and that, with the inflation news likely to be at least satisfactory, one ¼% cut in base rates will certainly be justified in 2006.

An alternative position - reflecting the rise in the annual rate of money supply growth to 12%, which is the highest since 1990 - is that excess money balances will lead to continued asset price buoyancy and above-trend demand growth in early 2006, and will need to be countered by a rise in the official REPO rate. The inflation news this autumn has been better than I expected (partly because of huge swings in air fares, whose effect on the most closely-watched inflation indices is new), but asset price developments (ie the rises in share prices, the fall in commercial property yields to 15-year lows, the return of house price inflation in central London and the very high cash flow multiples paid in private equity transactions) are consistent with the economy having excess money. The next few months will see the impact of large Merger and Acquisition transactions on bank lending, money growth and institutional liquidity. The implied money supply trends are good for asset prices in the short run, but worrying for inflation over the medium term.

I concede that actual consumer price inflation in recent months has been quite good, and that national output is probably close to trend. I think that interest rate rises will be needed in 2006, but I am happy to let base rates stay unchanged for the next month or two.

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

During the past month there has not been sufficient movement in the reported economic data to warrant a change of interest rates, either upwards or downwards. The economy is neither so weak as to need the stimulus of a rate cut, nor is it showing signs of any overheating or any incipient inflationary threat that would justify a rise in interest rates.

Retail recovery?
The two main signs of weakness in recent months have been the retail sector and the housing market, but in both areas there are signs of improvement, or at least stabilisation. In the retail sector, the first significant signs of recovery are starting to appear in anecdotal reports as well as in survey data. The CBI retail survey for December showed a sharp rebound, rising from minus 35 to 0, its biggest monthly increase in a decade. In addition, initial reports suggest a much more encouraging Christmas and year-end retail sales performance than had previously been expected.

Housing market has stabilised
In the housing market, a variety of house price indices and other measures such as mortgage applications have continued to exhibit stability or a modest upward trend, rather than sustained weakness. For example the Nationwide index of house prices rose by 0.5% in December, or by 3.0% year-on-year. Similarly, mortgage applications have continued to climb, rising to 113,000 in October, their highest level since June 2004.

Equities are strong
Elsewhere the strength of equity and commodity markets over the past year, such as the 17% rise in the FTSE-100 index in 2005, suggests that asset prices are holding firm in the current interest rate environment, and should support overall spending in the year ahead.

Softer labour market may be temporary
The labour market has shown some signs of softness, with wage increases moderating and unemployment on the ILO basis rising to 4.9%, but these appear to be temporary shifts, rather than the start of sustainable trends.

Inflation remains moderate…
Inflation also moderated in November, with the headline CPI slowing to
2.1% year-on-year and the core rate slowing to 1.5%. Manufacturing input prices in November (+12.7% year-on-year at the headline level) continued to reflect high fuel and commodity prices, but manufacturing output prices have slowed to 2.3%, their lowest increase in 18 months, showing that pipeline pressures are being absorbed in corporate margins and not being passed on to consumers.

…but broad money growth is rapid
With almost the sole exception of the monetary data, which continue to show uncomfortably high rates of increase for M4 broad money (+12.1% year-on-year in November, the highest growth rate since 1990), this overall picture of the UK economy implies no need for interest rate adjustments at the present time.

Comment by Ruth Lea (Director, Centre for Policy Studies, and Non-Executive Director of Arbuthnot Banking Group)
Vote: No change

Tight capacity means no immediate need for rate cut
There is little doubt that economic activity slowed last year, but there remain no signs of recession and the economy still seems to be running close to capacity. Granted, the labour market statistics are far from perfect, but they continue to indicate a tight situation. And public sector employment will continue to expand in 2006, probably taking up much of the slack in the private sector. There remains, therefore, no pressing case for a cut in interest rates.

Inflationary pressures remain subdued
Inflationary pressures have remained remarkably modest, with CPI inflation moderating from 2.5% (in September) to 2.1% (in November). But gas prices, reflecting the country’s vulnerable energy position, will surely give another boost to the CPI inflation rate in forthcoming months. Granted, there are few signs that higher inflationary pressures are feeding into higher wage settlements (at least in the private sector), because people assume that inflationary pressures will be kept under control. Such behaviour seems eminently reasonable, as the Bank will surely be successful in containing inflationary pressures in order to prevent the development of any nascent ‘wage-price spiral’.

Debt concerns will limit consumption growth
Growth is unlikely to pick up significantly this year. Household consumption growth will stay subdued, reflecting consumers’ reluctance to take on debt at the rate they have done in recent years. But, even though personal bankruptcies are picking up, there seem to be few signs of the extreme financial stress that was undoubtedly the case in the early 1990s, especially in the housing market. On the contrary, the housing market currently seems stable.

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

Monetary policy has been too loose for some time
Matters are still acutely balanced. Annual CPI inflation was down to 2.1% in November, and the survey data on retail sales continues to give a patchy picture, supplying the widely discussed case for a cut. However, the retail picture is far from clear, with a probably-important, but as-yet-unclear, effect from Internet shopping; oil prices have stopped falling for now; and broad money growth reached a worrying 12% in November, suggesting that the medium-term outlook for inflation should still be up, countervailing factors aside, and that monetary policy has been too loose for some time.

Interest rates are unlikely to be sustained at their present low level
That such remarkable broad money growth has been sustained for so long with only a modest associated rise in inflation is perhaps worth a short remark. One possible interpretation is that, over the past couple of years, matters on the real side of the economy (and in particular in the private sector) have been rather worse than widely thought, with overall prices and growth being sustained only by a considerable monetary injection and fiscal expansion. It may be that the loose money policy followed by the Bank was, in fact, the way to keep inflation at or around target. But keeping growth going for so long via monetary injection and fiscal expansion must eventually have consequences for the appropriateness of investments made in the period, and for the sustainable growth rate of the economy in the longer term. Also, if the real side should recover for itself, inflation could rise quite rapidly. Even if the next move in rates is down (which is still possible), over the medium term, rates will eventually have to be considerably higher than we have become used to recently.

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

Both demand and supply growth have weakened…
The state of the economy continues to be one of weak demand, though it has strengthened slightly in the past few months. The weakness probably reflects the tightening of monetary conditions into the early part of last year - in retrospect that looks like over tightening and, in particular, there was a misplaced enthusiasm to ‘hit the housing market’. Meanwhile, inflation is around 2%, with core inflation rather less. Supply growth has also slowed, probably to below 2.5% a year. The Chancellor’s tax policies, including a predilection for retrospective adjustments of tax and for windfall taxes, in particular, continue to create an environment of uncertainty and disincentives; the damage to entrepreneurship and productivity growth is now observable and reflected in competitiveness surveys.

…but demand has decelerated more than supply, justifying a rate cut
Nevertheless demand growth has slowed to less than this. It might seem tempting to punish the Chancellor by holding up interest rates; but it would not be the right role for monetary policy. It should go on being eased. A quarter point cut would be acceptable; but a half point would be good to get monetary policy back on track. As I have said before, I do not regard the growth of broad money as conveying useful information at its present rate, while M0 is growing rather slowly.

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

The British economy has surprised on the upside, but it is sensible to wait for more evidence on retail sales over Christmas

There is no doubt that the economy has been more buoyant than some people expected. Following rapid monetary growth, asset prices have been firm and the housing market has been recovering. As the effects filter through to expenditure decisions, I expect the economy to continue buoyant. The external environment has been very beneficial as well, with exports powering ahead for now. However, the behaviour of retail sales over the Christmas/New Year period is very important.

So far the evidence has been anecdotal. It would appear prudent to wait for official data, hopefully adequately reflecting what has happened to sales over the Internet, before raising interest rates. So for the moment my recommendation is to leave rates unchanged.

Comment by Professor Peter Spencer (University of York)
Vote: Cut rates by ¼%

Cut rates and allow the pound to weaken
Output is now well below trend, and inflationary pressures are dormant. The economy has taken the inflationary effects of the oil price rise in its stride and these are passing through without any apparent second-round effects. However, fuel and energy price increases, together with the effects of fiscal drag, have hit spending power hard, and a revival in the High Street is unlikely until real income growth is resumed. Export performance remains disappointing and it is difficult to see a strong pick-up in investment while output growth remains below trend. The MPC should cut interest rates until super-trend growth rates are achieved. The only snag that I can see is that overseas interest rates are on the way up. But the implication of this divergence is simply that the pound must be allowed to fall back, with the MPC taking its cue from sterling.

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

No strong case for changing the UK REPO rate at present
The MPC will probably, and correctly, feel reluctant to change interest rates in early January, when it will still have only the sketchiest of ideas about the strength of retail sales over the important Christmas and post-Christmas sales periods. February, when the Committee will have a new set of Inflation Report forecasts available, is more likely to see a rate change, however, although that will depend on events between now and then. Recent statistics suggest that there is no urgent need for action of any sort, with target CPI inflation having eased to 2.1% in November, but some signs of a stabilisation (if not a rebound) appearing in the housing market. Claimant-count unemployment has risen by 88,200 since its January 2005 trough, and manufacturing activity remains disappointingly weak. However, the latter may primarily reflect the damage done to the economy’s supply side by Labour’s tax and regulatory policies, which should have a disproportionately negative impact on the tradables sector, in theory.

Sterling could prove vulnerable if Britain cut its interest rate while other countries were raising theirs

The prospect of another US rate rise on 31 January, and a possible further increase in the Euro-zone, would leave sterling looking distinctly vulnerable, if Britain was to cut rates at a time when other countries were raising theirs, particularly as Britain’s relatively rapid monetary growth and poor balance of payments figures are also likely to be eventually reflected in a downwards movement in the external value of the currency. Overall, the evidence suggests that Britain’s official REPO rate should be left unchanged at 4½% on 12 January, leaving February available for a rate change if the balance of risks suggests that this is appropriate.

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

Household consumption and business investment remain weak
Initial indications suggest that, apart from a two-day shopping binge after Christmas, the underlying deterioration in retail spending trends is undisturbed. As the softer outlook for consumer spending is confirmed, the stakes are raised regarding the credibility of a rebound in business investment and/or business exports. Business investment is edging higher in real terms, but remains
over-dependent on the expenditures (and profitability) of the private business services sector (excluding distribution services). Moreover, data releases in Christmas week confirmed that total private sector investment in computer hardware is down 15% on a year ago, and computer software spending is 8.5% lower on the same basis. With capacity utilisation at quite ordinary levels in the manufacturing sector and services profitability under threat, the motivation for stronger business investment is questionable.

Real interest rates remain high after allowing for low ‘core’ inflation in the private sector
While the private sector goods and services’ inflation rate has ticked up again, to 1.4% in November, a REPO rate of 4.5% still implies a real interest rate in excess of the long-term potential real growth rate. As the public sector withdraws its growth impetus under pressure from the fiscal arithmetic, the burden of fulfilment of official forecasts for economic growth rests with a revival of private sector activity. Unless the REPO rate is cut in the early months of this year, there is little hope of that occurring. My vote is for an immediate cut of 25 basis points, with increasing pressure on the MPC to act at their February meeting.