Thursday, February 16, 2006
What will move the Bank?
Posted by David Smith at 08:00 AM
Category: Thoughts and responses

A busy week. Inflation has unexpectedly fallen below target (1.9% in both December and January) and the Office for National Statistics' assessment of the labour market is that the employment rate is trending lower and unemployment trending higher. On the face of it these are conditions under which interest rates might be expected to fall.

But the Bank of England is not, yet, having any of it. Mervyn King, a cricket fan, played the straightest of bats in presenting the quarterly inflation report on February 15. This is a flavour of what he said:

"The picture of the UK economy painted by the latest official data is of a rather shallow slowdown followed by a return to growth of GDP close to its long-term average. Inflation is close to the 2% target, and its recent movements have been dominated by changes in energy prices. The outlook described in today’s Report contains a benign central view of steady growth with inflation remaining close to the target over the forecast period.

"Since the November Report, low long-term interest rates have contributed to a rise in asset prices, both at home and overseas. Equity prices have risen by almost 10% over that period, and almost doubled over the past three years. During the past year the housing market has picked up in terms of both prices and activity. Broad money growth has reached its highest level for fifteen years, and the exchange rate is a little weaker than in November. Those developments are likely to support domestic demand. The slowing of consumption growth appears to have been relatively short-lived, falling noticeably below its long-term fifty year average only during the first half of last year, and picking up thereafter. Whether that recovery will persist, only time will tell.

"Business investment remains subdued. Cost pressures have lowered profit margins and, despite low long-term interest rates, surveys show few signs of any immediate recovery.

"In the Committee’s judgement, the central view is that consumer spending is likely to grow at around its long-run average rate throughout the forecast period, business investment will recover slowly and net trade is likely to make less of a negative contribution to output growth over the forecast period than it has in recent years.

"As a result, the central projection is for GDP to grow at around its long-run historical average ... The central projection is for CPI inflation to remain close to the 2% target throughout the forecast period.

"There are risks to the central views for growth and inflation – both on the upside and the downside – and on these there are some differences of view among Committee members, but those are small relative to the uncertainty surrounding the central projections ... In the Committee’s view, the balance of risks to the path of demand is slightly on the downside, associated with the outlook for consumer spending and net trade, which poses downside risks to inflation. But, in the Committee’s judgment, there are also upside risks from the path and possible impact of energy prices and the uncertainties about the extent of spare capacity in the economy at present."

Two conclusions can be drawn from that. One is that are differences of view among MPC members, but King's description of them as small suggests the divide is not huge. I doubt he would say this if the MPC had split 5-4.

The second is that the MPC is unlikely to move until it is clear how the current picture for the housing market and consumer spending is playing out. That won't be entirely clear for some weeks. Rates are on hold.

Stop press: Official figures show that retail sales volume fell by 1.3% between December and January.

Comments

An excellent summary David.

"There are risks to the central views for growth and inflation – both on the upside and the downside – and on these there are some differences of view among Committee members, but those are small relative to the uncertainty surrounding the central projections ... In the Committee’s view, the balance of risks to the path of demand is slightly on the downside, associated with the outlook for consumer spending and net trade, which poses downside risks to inflation. But, in the Committee’s judgment, there are also upside risks from the path and possible impact of energy prices and the uncertainties about the extent of spare capacity in the economy at present."

This is one of the clearest paragraphs of guarded Bank-speak I've seen. It says it all whilst saying nothing.

Looks like your prediction of hold with a quarter-point cut in the second half of the year, remains likely.

My prediction of hold , raise by quarter in march and two more quarter point raises in second half is now under pressure.
I'm sticking with it though as I can still see the US rising above 5.25% by end of year.

Posted by: assetpriceinflation at February 16, 2006 09:25 AM

"Stop press: Official figures show that retail sales volume fell by 1.3% between December and January."

David

Presumaby Mervyn King will have seen these figures before he made his comments about the state of the economy. This kind of leaves two possible explanations......

1) He genuinely believes January is a blip and not too much should be read into it (ie we take his comments at face value).

2) He has concerns that it is the start of a trend but does not want to set hares running over lowered interest rates because of the danger of reigniting asset inflation which he might feel is the worse of the two evils.

Anecdotally the January spending dip has continued into February and if anything accelerated. So I incline to the latter, especially as Merv has access to a wide variety of information including leading indicators of the economic situation in advance of the official stats.

Do you have a view on this starnge situation of Mervyn being steady/upbeat on the ecdonomy and the retail figures appearing to contradict this?

David

Posted by: David Brown at February 19, 2006 07:04 PM

I think he may be assuming that non-retail consumer spending is stronger than retail - retail sales account for only about 40% of all consumer spending. He's probably also sticking to his previously-stated view that the retail sales picture generally stays foggy until Easter. Other MPC members may take a different view.

Posted by: David Smith at February 19, 2006 08:30 PM
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