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 completed during working hours on Tuesday 28 March, before the announcement of the widely anticipated ¼% hike in the US Federal Funds rate to 4¾% on Tuesday evening, and the UK rate recommendations are with respect to the Monetary Policy Committee (MPC) rate decision to be announced on Thursday 6 April.

On this occasion, there was a cliff hanger, and it was not until the very last vote was cast that the outcome was determined. In the event, four SMPC members voted to cut rates by ¼% in April, while five SMPC members voted to hold. 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 next one will be held at the IEA on Thursday 20 April at 6:00pm. The minutes from this physical meeting will be released ahead of the 4 May rate decision.

A number of SMPC members have contributed recently 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.

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

The situation remains little changed since last month. As widely expected, the budget was neutral. The jury is still out on consumer spending, but there is no real sign of a strong pick-up in economic growth which would be needed to absorb the economy’s spare capacity. With every passing week it is more and more certain that the danger of a pass-through from higher energy prices into wages and generalised inflation is not going to be realised. If interest rates are not cut, then the probability is that there will be a significant undershoot of the inflation target.

It seems clear that the MPC is very reluctant to cut rates so that I no longer forecast an imminent cut. But I would vote for one.

Comment by Professor Tim Congdon (Visiting Fellow, London School of Economics)
Vote: No Change

Not much has changed in the last few weeks to alter interpretations of the UK economic scene. Business surveys have strengthened further, against the background of a strong world economy. Rather high UK money growth has continued, helping asset prices. (The prices of UK equities and London houses - which are substitutes for wealthy people - have moved ahead quite strongly, while valuations in the private equity world are widely regarded as at ‘bubble’ levels.) For the moment the buoyancy in asset prices has not led to stronger consumer spending, but lags between money and asset prices, and between asset prices and expenditure, have been long and variable in other cycles. The re-appearance of lags in this cycle in no way invalidates the basic relationships.

The quite sharp rise in unemployment in February was surprising, but should not be taken as indicative of an emerging negative output gap. I favour a rise in base rates, but am happy to wait until the evidence of asset price effects on demand is clearer. A cut in base rates might spark a fall in the pound.

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

Trend growth
In the second half of last year the economy returned to ‘trend’ growth, according to the ONS’s data. But indicators for the first quarter are mixed. Household spending in the first quarter of 2006 looks weaker - January’s and February’s retail sales data suggested slower growth, possibly reflecting the impact on personal spending of higher fuel and utility prices. Against this, the housing market seems to have firmed and some survey evidence on business activity looks stronger.

Unemployment
It could be argued that the pick-up in unemployment is indicative of deficient demand and the consequent need to cut interest rates. Unemployment in the three months November 2005 to January 2006 was some 109,000 higher than a year earlier and the unemployment rate was 5.0% compared with 4.7% a year earlier. But unemployment still remains low by historical standards.

Capacity uncertainties
Moreover, there are very real difficulties in assessing the degree of ‘spare capacity’, given the recent poor business investment record and, more generally, the appalling productivity performance. Whole economy productivity growth seemed to stall in the second half of last year. Even though some of this deceleration is likely to be cyclical, there has to be the risk that some of the slowdown is structural and trend output growth (in annual terms) could be slowing from the Treasury’s 2½% to 2¾% estimate to 2% - or even less.

Inflation and earnings
CPI inflation ticked up to 2.0% in February but earnings inflation is still subdued, with no current sign of earnings inflation picking up despite higher fuel bills and the prospects of inflation-busting Council Tax increases. However, the Bank/NOP survey for February suggested that consumers’ inflation expectations may have shifted up. This, in turn, suggests a degree of caution about inflationary developments. All in all, there is still no case for raising interest rates.

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

Inflation well controlled, despite rapid money growth
Despite continued rapid monetary growth, inflation seems well under control. CPI is on target, at 2.0%. Despite the well-known fairly rapid rises in input prices (up 10.7% on the narrow measure in the year to February), factory gate output inflation has tended to drift downwards over the past year, and the narrow measure (excluding volatile sectors) is now at 1.8% (with the broad measure at a fairly benign 2.9%). In the year to January, private sector earnings growth was just 3.3%. The rapid broad money growth of recent years has now not been reflected in goods and services prices for so long that the question must arise: How much will ever so appear? At this stage a reasonable assumption would still seem to be that, in the medium term, interest rates must be rather higher than now, but there is little evidence that interest rate rises are any matter of urgency.

Cutting rates would be a worthwhile experiment to test size of output gap
On the contrary, with the inflationary environment so benign there is an opportunity to test, slightly, the claims of those that believe the output gap is rather larger than one might suppose. A small cut in interest rates at this stage might facilitate some pick-up in investment. The MPC appears deterred by the possibility of stimulating further rises in house prices. But, as this commentator has argued previously, the MPC has neither the remit nor the power to control house prices. The behaviour of the housing market is mysterious, but it must be allowed to find its own level, with the MPC anticipating such moves and/or reacting afterwards, rather than attempting to manipulate.

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

Asymmetric response of inflation to output gap
There is a good argument that if the economy is below capacity and inflation is low and stable, a small cut in the rate of interest would have a stronger effect on demand than on inflation. However, if the economy is at capacity or above capacity, the effect of a cut in the interest rate on inflation would be greater than on demand. Whatever one thinks about the argument of the asymmetric response of inflation to the output gap, the policy prescription really depends on whether the output gap can be measured with sufficient precision to know if the economy is just above or just below capacity.

Rapid monetary growth implies need for caution
The economy has indeed slowed down, but whether this is from a position of positive gap or negative gap is uncertain. However, broad money growth, which is an indicator of future demand, remains uncomfortably high and continues to suggest that interest rates should be raised in the not-too-distant future. Even narrow money growth, which is usually a good coincident indicator has risen to around 6% year-on-year. It is hard to balance these trends with an inflation target of 2% when inflation is currently at target. The behaviour of the economy and the monetary aggregates are a puzzle for those who believe that, ultimately, inflation is a monetary phenomenon. While the economic indicators continue to point in opposite directions, it might be better to ‘wait and see’ rather than move policy in one direction or the other.

Comment by Professor Anne Sibert (Birkbeck College)
Vote: No Change

Offsetting factors imply need for caution
Following last year’s slowdown in GDP growth, the labour market has weakened and, in February, there was an unexpectedly large jump in the number of people registering for unemployment. Output growth, however, should be near trend this year, and inflation is likely to remain near target. Risks include possible effects on both supply and demand of high energy prices and immigration. On balance, there is no clear argument for a rate decrease.

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

Output is below trend
Output is well below trend. Consumer spending is weak and is unlikely to strengthen until real income growth improves. With employment and earnings growth faltering and fiscal drag continuing to bite into spending power, the prospects for that remain poor. Export performance has been very disappointing and I can’t see anything likely to change that. 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

The UK Budget
The 22 March Budget indicated only a marginally worse outlook for public borrowing in the forthcoming financial year than had been indicated in the December 2005 Pre-Budget Report, but a noticeably worse one that was predicted in the March 2005 Budget, something that might cast doubt on the credibility of the new projections. There are two main concerns for monetary policy that arise from the 2006 Budget. The first is whether the adverse supply-side effects of the Budget are sufficiently severe to close the output gap from a shortfall of supply, rather than an excess of demand. The second is whether the financial markets take fright at the Chancellor’s self-declared commitment to tax-and-spend policies and pull the rug out from under sterling. It is also worth bearing in mind that, in simple quantity theory terms, a withdrawal of national output from the private to the public sectors can be directly inflationary. This is because it reduces the supply of goods that the private sector has available to soak up money balances. This effect operates separately from any adverse supply side effects of tax-and-spend policies on the level and growth of real GDP.

Noticeable patches of weakness
Recent UK data have shown patches of noticeable weakness, including in the labour market, and there have also been some unpleasant downwards revisions to earlier official estimates of manufacturing production in both 2004 and 2005. Annual CPI inflation is also on target, at precisely 2% in the year to February, and sterling is slightly on the weak side but not a serious current problem, with the old IMF trade-weighted index standing at 102.1 (1990=100) on 28 March, and the new index recording 98.6 (January 2005=100). However, broad money growth is currently too rapid at 12.2% in the twelve months to February, and the renewed strength of the housing market, and arguable frothiness in UK equities and bonds suggest that the UK now has the symptoms of an excess supply of money, which is not the same as claiming that the demand for money is invariant and the supply of money is exogenously fixed. It can be argued that the labour market is a lagging indicator of the main business cycle in output and activity, while financial markets perform a leading indicator role. This interpretation would suggest that recent figures tell us that national output was weak around the middle of last year but is likely to pick up strongly over the next few quarters.

But dangerous to cut rates when fiscal discipline is questionable
This is probably an excessively Panglossian interpretation of the specifically British outlook, although there is growing evidence that the world economy is starting to surprise on the upside. This is a mixed benefit for Britain, however, because it also means that we may have to follow global interest rates upwards if we are to avoid a run on sterling. On balance, the overall risk assessment suggests that it could be dangerous to cut UK rates while domestic fiscal discipline is questionable and world rates are trending upwards. Britain’s fiscal and regulatory policies have now lost most of their credibility in the financial markets, and it could be seriously destabilising if the same view was taken about the credibility of monetary policy as well. The recent loss of two MPC members, although for good and understandable reasons, may also have some minor adverse effects on market confidence, particularly as only eight members will be voting in April and May, until Mr Lambert’s as yet unknown replacement is in place. Overall, there seems to a strong case for leaving rates unchanged in April, and it is not difficult to foresee situations under which the official REPO rate will need to end up ¼% 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%

Tax-and-spend policies could undermine the private sector, and create adverse supply-side effects
The March 2006 Budget reaffirmed the government’s commitment to raising the tax burden, irrespective of the condition of the economy. The Treasury’s response to undershooting tax revenues is to close loopholes, reduce the value of tax allowances and to increase tax rates. This strategy invites the possibility of an alarming scenario in which the tax take responds adversely to the latest policy tightening and the government is forced either to borrow aggressively or to cut spending. Such a scenario is most easily envisaged in the context of a relapse in financial market valuations and turnover levels, from which the tax yields (stamp duty, capital gains tax, income tax and corporation tax) have been plentiful in recent years.

General sense of unease
The latent instability of the public finances adds to a general sense of unease, which derives from the softening outlook for consumer spending and business investment and the vulnerability of export performance to a US consumer downturn. Added to which, the bounce in housing market activity in the second half of 2005 may be close to an end. The Rightmove average asking price for UK residential property recorded only a 4.3% uplift in March on a year ago, suggesting that the surge in transaction volumes has scarcely improved the bargaining power of house vendors. Seasonal trends in property transactions have been erratic in recent years, but January’s seasonally adjusted figure of 133,000 is lower than each of the previous four months’ readings.
Low REPO rates have stimulated financial activity but not the real economy
It is clear from the M4 lending data that prevailing interest rate levels remain attractively low for financial market borrowers, private equity firms and others engaged in merger and acquisition (M&A) activity. However, it is far from obvious that this latest bout of M&A activity will have stimulatory macroeconomic effects or that inflationary pressures will result. On balance, there is still scope for a minor downward adjustment in the REPO rate, initially to 4.25%.