Sunday, March 05, 2006
Shadow MPC votes 5-4 to cut rates
Posted by David Smith at 09:00 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 SMPC poll was carried out on Tuesday 28 February and the rate recommendations are with respect to the Monetary Policy Committee (MPC) rate decision to be announced on Thursday 9 March. On this occasion, five SMPC members voted to cut rates by ¼% in March, while four SMPC members voted to hold, although some of the holds had a bias to raise rates at a later date.

The wider economic background is discussed in more detail in the quarterly SMPC minutes. The last quarterly meeting was held on 17 January and the results were written up in our 6 February SMPC release. The next quarterly SMPC meeting will be held at the IEA on Thursday 20 April, and the minutes from this physical meeting will be released ahead of the 4 May rate decision.

Comment by Roger Bootle (Economic Adviser, Deloitte)
Vote: Cut REPO rate by ¼%

The data continues to be mixed, although the lower-than-expected inflation numbers and continued underlying softness of the real economy continue to support the case for a rate cut.

But the Bank’s February Inflation Report was not encouraging in this regard, and the Minutes of the last MPC meeting showed that only one member voted for a rate cut. In these circumstances, although I would vote for a cut, an early move is unlikely. The next likely date is May, to coincide with the next Inflation Report.

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

The start of 2006 has been a fascinating time, with many forecasters expecting weakness in consumer spending in the UK and elsewhere (due to rising energy bills) to foreshadow a more general economic slowdown. By contrast, rather high money supply growth (again in the UK and elsewhere) argues for strong asset prices and buoyant demand. In practice, the stock market and housing wealth in the UK are moving upwards, and business surveys are improving.

My judgment is that UK output is roughly at trend, but that above-trend growth in domestic demand will be recorded at present interest rates, while the world economy is still enjoying high growth. Further rises in utility bills will hit the inflation numbers this spring. I cannot see the growth rates of credit and money declining to much under 10% a year with base rates at 4½%. I favour a ¼% rise in base rates, but there is no desperate hurry.

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

UK growth is in line with potential
Aside from a weak retail sales report for January, the UK economy has continued to show signs of growing very much in line with its potential. Real GDP for 2005 Q4 was up 0.6% quarter-on-quarter, or about 2.4% at an annual equivalent rate, and both house prices and share prices have been buoyant, suggesting there is ample latent purchasing power in the economy without further stimulus.

High energy costs have suppressed retail sales
The data releases on current output and production continue to be mixed. For example, business investment for 2005 Q4 was reported down 1.0% quarter-on-quarter, but the CBI monthly survey of manufacturers’ orders for February showed a notable improvement after six months of weakness. Retail sales in January, on the other hand, appeared to lose the gains recorded in November and December. High energy prices, and especially prospective increases in natural gas prices, may be acting as a depressant on consumer spending in other areas.

Housing recovery
In the housing market, a variety of house price indices and other measures such as mortgage applications have continued to show a renewed - though mild - upward trend. This upswing is paralleled by the steady rise in the FTSE-100 Index over the past four months. Both suggest that monetary policy has been somewhat easy, and this is confirmed by the extended double-digit growth of M4 broad money, which was up 11.7% on the year in January, according to the provisional estimates.

Labour market
The labour market has shown some signs of softness, with whole-economy wage increases moderating to 3.6% year-on-year in December (after 4.2% last July) and unemployment on the Labour Force Survey basis rising to 5.1% in December from 4.7% in September. However, the claimant count has remained steady, at 2.9%, for the past four months. The softening therefore appears to reflect temporary factors rather than the start of any sustained weakening.

Consumer and producer prices
Inflation also moderated slightly in December and January, with the headline CPI slowing to 1.9% year-on-year and the core rate slowing to 1.2% from 1.8% in July. Manufacturing input prices in January (which were up 16.2% on the year) continued to reflect high fuel and commodity prices, but manufacturing output prices have remained in the 2-3% range for the past four months, showing that pipeline pressures are being absorbed in corporate margins and not being passed on to consumers.

My overall assessment is that this 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

GDP data suggest that there is no need for further stimulus
GDP data relating to the second half of last year do not indicate an economy desperately in need of further monetary stimulus. Growth in Q4 was 0.6%, reflecting a pick-up in services growth, and much ‘at trend’ following a revised third-quarter figure showing 0.5% quarterly growth. (The previous estimate had been for a 0.4% increase.) The 0.6% increase was recorded despite another appalling quarter for manufacturing output, which registered a 1.0% quarterly fall. The indicators so far available for the first quarter of 2006 are mixed. January’s retail sales were softer, but the housing market seemed to have firmed, and survey evidence on business activity looked a little stronger.

Capacity uncertainties
It could be argued that the pick-up in unemployment is indicative of deficient demand and the consequent need to cut interest rates. But unemployment remains low by historical standards. Moreover, there are very real difficulties in assessing the degree of ‘spare capacity’, given the recent poor business investment record and, more generally, the government’s undermining of the economy’s potential growth. The expanding public sector’s ‘squeezing out’ of private sector activity, along with the government’s continuing regulatory assault on business competitiveness, must surely be taking its toll. Whole economy productivity growth has slowed significantly. Even though some of this deceleration could be cyclical, in the words of the MPC January minutes “there remained a possibility that underlying total factor productivity had slowed”. Ominous words indeed.

CPI inflation is under control
As CPI inflation remains close to target and earnings inflation is under 4%, with absolutely no sign of earnings inflation picking up, despite higher fuel bills and the prospects of inflation-busting Council Tax increases, there is no case for raising interest rates.

Comment by Dr Andrew Lilico (Europe Economics)
Vote: Cut REPO rate by ¼%

A one-off cut would test the degree of spare capacity
Although M4 growth rates of around 12% continue to be a concern, with inflation at just below target (1.9%) and oil prices easing slightly (down to around US$60 a barrel from recent highs around US$68), there is a window of opportunity to test the thought that the output gap might be larger than is currently believed. This should not, however, be seen as the first in an extended series of cuts - indeed cutting earlier, rather than later, may provide the opportunity to raise rates further than would otherwise be the case later in the year.

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

Supply side has been damaged by interventionist policies, but demand is independently weak, justifying a rate cut
UK demand continues to be weak. There has also been a collapse in productivity growth. This is linked to the damaging supply-side policies of this government: a combination of fast-rising waste in the public sector, rises in a variety of marginal tax rates and unpredictable changes in regulation, such as in the pensions industry. Investment has also stagnated. One could reasonably argue that monetary policy can do little about this, since much of the damage is coming from these supply-side policies. This is true. However, since demand is plainly so weak, it should not neglect this aspect either. Here it can moderate the economy’s travails by cutting interest rates. I would recommend a further ¼% cut at once. There is also now a shortage of long-dated gilts and, in particular, of index-linked securities; witness the difficulties of the pensions industry. This is now a time to take advantage of the rising debt/GDP ratio to issue more at the long index-linked end of the market.

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

Below-trend output warrants a rate cut
Output is now below trend and this has restrained the effect of increasing energy prices on inflation. We have yet to see the full effect of rising utility bills on the CPI but, judging by last year’s increase in fuel prices, these are likely to hit consumer spending rather than trigger second-round increases in wages. Consumer spending picked up over the Christmas period, but a sustained revival in the High Street is unlikely until real income growth improves, and with employment and earnings growth faltering and fiscal drag continuing to bite into spending power, the prospects for that remain poor. Export performance remains disappointing and a strong pick-up in investment is unlikely while output remains below trend. Interest rates must be cut until output moves back into line with the non-inflationary trend.

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

MPC unlikely to change rates in March
The fact that the MPC chose, on an eight to one majority, not to alter the official REPO rate in February, which was an Inflation Report month, suggests that they are extremely unlikely to do so in March, even without the complication of the annual UK Budget announcement on 22 March.

There is a widespread expectation that the European Central Bank will raise its REPO rate by ¼% to 2½% on 2 March (Editorial Note: as transpired), and the US Federal Reserve could well raise the Fed Funds rate by ¼% at one or both of its next two meetings, scheduled for 28 March and 10 May. With the US Prime Rate already standing at 7½%, which is equivalent to a UK REPO rate of 6½%, there may be less need for aggressive rate hikes in the US than some people seem to fear, however, even if headline US CPI inflation was 4% in the year to January, compared with the 2.4% recorded in the Euro-zone over the same period. However, with Japan also likely to be moving towards a less accommodating monetary stance in the next few months, Sterling could look distinctly vulnerable if Britain were to cut its REPO rate at a time when other countries were raising borrowing costs.

Sterling is not an immediate problem, but non-oil GDP may be growing close to trend
As of now, Sterling is not a problem, with the old IMF trade-weighted index standing at 103.1 (1990=100) on 28 February, and the new index recording 99.3 (January 2005=100). CPI inflation was just below its 2% central target, at 1.9% in the year to January, but could take a hit from higher gas prices over the next few months. Furthermore, the fact that the deficit on Britain’s net exports of goods and services equalled 4.4% of the factor cost measure of GDP in 2005 suggests that there may be suppressed inflationary pressures. The run-down in North Sea oil production in 2005 means that non-oil GDP rose by 2% last year, and also by 2% in the year to 2005 Q4, which is more buoyant than the 1.8% shown for both periods by the headline growth numbers. In addition, the initial GDP growth estimates are likely to be boosted, eventually, by ¼% or so, if past revisions are any guide, suggesting that the non-oil economy is probably already growing broadly in line with a cautious estimate of productive potential. The continued rapid growth of M4 broad money, and the renewed strength of the UK housing market, also suggest that the main risk is that demand will turn out to be stronger than expected, even if this may not be reflected in the GDP figures because supply constraints cause home demand to be satisfied by imports, rather than home production.

Overall, there seems to a strong case for leaving rates unchanged in March, and it is not difficult to foresee situations under which the official REPO rate will need to end up ¼% or ½% higher by the year end. However, this depends on international interest rates and the nature of future, and inherently unforeseeable, random shocks.

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

There are three critical contexts in the UK economy at present and, for once, the housing market is not among them. It is hard to construct a plausible scenario in which equity withdrawal will impart a positive impetus to households in 2006 as compared to 2005.

Squeezed personal incomes
The first, and most important, is the outlook for personal disposable income. Working age employment dipped by 105,000 in Q4 of last year, private sector annual earnings growth has dropped to 3.3%, and total employment compensation rose by only 0.7% in Q4, according to the national accounts. The certainty of a rising tax burden in 2006 implies an even greater squeeze on consumer spending this year than last, giving a predisposition to ongoing economic weakness.

Rising bad debts
The second context is the battle between the expansionary impact of double-digit percentage growth rates of the M4 credit and money aggregates vs the contractionary impact of soaring consumer debt defaults and arrears that left some credit card companies with charge-off rates of more than 7% at the end of last year. The remarkable deterioration of household credit quality in 2005 continues to weigh heavily on consumer spending, and the January pullback in retail sales was not unexpected.

Money supply
UK monetary data also reveal some bizarre developments, including 26.5% annual growth of M4 holdings by other financial corporations, and an 18.3% growth rate of M4 lending to private non-financial corporations. Neither presents a serious threat to consumer price inflation in my view.

Capital formation vulnerable
Thirdly, there seems less reason than before to anticipate an investment recovery now that corporate profitability has peaked. Indeed, real gross capital formation (which includes the change in inventories) fell 1.8% in Q4 and stands 1.7% lower than a year ago. Business investment was spared an even greater decline in Q4 by a surge in private non-distributive services’ capital spending. This category suffered a pronounced cutback after the 2000 equity market peak and there are grounds to expect a repetition.

Money GDP
With annual growth in nominal GDP of only 3.7% in the year to Q4, it seems appropriate to make a modest reduction in the REPO rate, considering the risks to private domestic demand outlined above.

* A number of SMPC members have contributed to a new book on monetary policy and the financial markets, Issues in Monetary Policy: The Relationship Between Money and Financial Markets, edited by Kent Matthews and Philip Booth (John Wiley & Sons Ltd in association with the IEA), which also includes a contribution by Mervyn King, and an appendix by Milton Friedman.

There will be a book launch at the IEA on Tuesday 7 March at 6:30pm, when copies can be obtained for £25.00 (Normal Price £39.99). Further details can be obtained on


David, in my opinion you are speaking the most sense here by a country mile. I'm amazed that nobody else really mentioned the wider context of tightening by most major central banks, the risks to sterling, and the risk of sending asset prices further into the stratosphere rather than stimulating the economy by cutting rates.

As for the gentleman who cited rising bad debts as a case for cutting rates, when it is in fact the lax lending due to low rates that has caused these bad debts - words fail me!

Posted by: EL_Pirata at March 5, 2006 10:40 AM

They all sound like amateurs to me, and ego strokers.

Don't care about quality of life issues such as responsible lending and affordable housing.

Banker: I've managed to get people indebted up to the eyeballs, but now they are struggling to pay it all back.

Economist: No worries will just cut the rates and money will be growing on trees.

Posted by: BillyTheFish at March 5, 2006 11:14 AM

How many times in modern history do "experts" need to be proven wrong for reality to sink in?

Trust anecdotal evidence. Soaring unemployment, sky-high property prices, record high bad debts and Euroland is raising interest rates, but according to these gentlemen, the answer is cutting interest rates?

Stop tippy-toeing around the elephant in the living room. Raise interest rates and bring asset prices down to long-term averages in line with the IMF recommendations. If you lower them any further they'll stop having any affect at all.

Posted by: Paul Owen at March 6, 2006 12:14 AM

In previous minutes Peter Warburton has cited low private sector goods and services inflation as a reason to cut. Where can I find and follow this measure? Is it in the CPI release - I don't think it is - or do I need to construct it? If so which components has he taken out?

Thand and regards Ian Amstad

Posted by: Ian Amstad at March 21, 2006 02:26 PM

My question goes to Ian Amstad and it is this. I am looking for a relative by the name of Ian Amstad who lived in Bexhill, Sussex in the 1950's. Would you be that person?

Posted by: Robert Butterworth at May 5, 2009 12:20 PM

Robert - no because I was born in 1963 - but please email me, because you have piqued my interest - Ian

Posted by: Ian Amstad at August 14, 2009 08:57 PM