Sunday, April 01, 2007
Shadow MPC votes 8-1 for April rate hike
Posted by David Smith at 10:59 AM
Category: Independently-submitted research

The outcome of the latest Shadow Monetary Policy Committee (SMPC) monthly E-Mail Poll (carried out in conjunction with the Sunday Times) is set out below.

The rate recommendations are made with respect to the Monetary Policy Committee’s (MPC’s) Bank rate decision to be announced on Thursday 5 April. On this occasion, six SMPC members voted to raise Bank rate by ¼% on 5 April, two wanted the shock therapy of a ½% increase, and one voted for a ¼% reduction because of concerns about the US property shakeout amongst other factors.

There was a discussion amongst the proponents of a rate increase as to whether it was better to wait until the 10 May MPC decision, when a new set of Inflation Report forecasts would be available, and as the financial markets seem to be expecting. However, the dominant view was that Bank rate should have been raised last month, if it were not for the transitory period of stock market weakness then occurring, and that it was now appropriate to make up for lost time.

Comment by Roger Bootle
(Economic Adviser, Deloitte)
Vote: Raise rates by 0.25%
Bias: Raise rates more

It came as no surprise that the MPC did not raise rates last month, particularly given the turmoil in financial markets. But the fact remains that the latest Inflation Report laid out a path under which inflation retuned to target on the assumption of a further rise in interest rates. So the MPC has laid the groundwork for another rise and it is important that it now carries through into action – unless there are compelling reasons in the data not to. In my view the data continue to support the case for higher rates. Inflation itself ticked up, retail sales rebounded, there are increased signs of the ability of firms to pass through cost and prices rises and house price increases are still very strong. The fact that inflation will fall very sharply in the second half of the year should not deter the MPC. There could be a case for waiting until the next Inflation Report in May but it is not compelling. Better to get on with the job and raise rates now.

Comment by Philip Booth
(Cass Business School and IEA)
Vote: Raise by ¼%
Bias: Then neutral.

The monetary data have been a concern for some time. Inflation has now turned up and, though most forecasters expect it to return towards the 2% target, it will only do so if real interest rates are not allowed to decline as inflation rises. In other words, when inflation rises, all other things being equal, there is a potential for a slackening of monetary policy if interest rates remain the same. The dangers of deflation over the next two years are probably close to zero and the dangers of a continuing rise in inflation and the associated loss of credibility are such that it is better to continue to take action now.

Comment by Tim Congdon
(Visiting Fellow, London School of Economics)
Vote: Raise by ½%
Bias: Then neutral

The post-1997 system of inflation control is in trouble. The annual growth rate of money (on the M4 measure) continues to run in double digits, whereas the rate consistent with on-target inflation must be in the single digits. The economy certainly suffers from a condition of ‘too much money chasing too few assets’. In this cycle the excesses have been more in unquoted equity and commercial real estate, and less in quoted equities, than in past cycles. Nevertheless, the general buoyancy of asset prices remains a marked feature of the economy. House prices are extremely high relative to personal incomes, but the last few months of numbers from the Halifax and Nationwide series suggest further rises of about 1% a month. There is a great deal of anecdote that, as in past boom-bust cycles, the London housing market has gone berserk.

Output is probably about ½% above trend, with ‘the natural rate of unemployment’ rising because of employment legislation and increases in the minimum wage. The volume of retail sales is about 5% above its level in the first quarter of 2006, while business surveys are strong and imply that corporate capital spending will climb in 2007.

At present interest rates, annual M4 growth is unlikely to return to single digits. Although base rates have risen from 3½% to 5¼% so far in this cycle, mortgage approvals are roughly 50% up on their levels two years ago. Corporate finance departments are working flat out on an assortment of Merger and Aquisition (M & A) deals, virtually all of which involve bank finance and will create new money balances (initially in the financial sector).

On top of these background determinants of the inflation rate, we have the plain facts of above-target consumer price inflation (even if the figure is still within the 1%-plus-or-minus corridor) and a headline retail price inflation rate of over 4%. Last month I recommended a ½% increase in base rates. That remains my favoured course. My only qualification is that the sub-prime mortgage imbroglio in the USA is a relatively new and as yet imponderable factor in the global scene. It has no direct relevance to British monetary policy. But I would acknowledge that – if it were to precipitate big stock market falls – it should have a bearing on the timing of UK interest rate increases.

Comment by Ruth Lea
(Director, Centre for Policy Studies, and Non-Executive Director of Arbuthnot Banking Group)
Vote: Raise by ¼%
Bias: Thereafter no change

The minutes of the March MPC meeting made for interesting reading. Eight people voted for no change whilst one, David Blanchflower, voted for a ¼% cut. Whilst the majority’s wish to keep rates on hold during a period of market turbulence seems perfectly understandable the wish to cut rates does not.

Even though the recent fears of a wage-price spiral seem to be receding, recent data on wage settlements and earnings have been relatively benign, other data suggest further tightening would be a sensible move at the juncture. Since the March MPC meeting, ONS data suggest that there remain inflationary pressures in the economy and growth remains robust. February’s RPI inflation was an above expectations 4.6% (compared with February’s 4.2%) whilst CPI inflation was 2.8%. February’s retail sales were also stronger than expected, following a weak January and in the words of the ONS “underlying growth…remained robust and close to the long-run average.” The housing market also remains robust and the rise in unemployment has flattened off (if anything it is falling slightly). The Budget was broadly neutral.

I see no reason in delaying a further increase in rates and recommend a ¼% increase –which I would consider sufficient tightening for this cycle on current data. But I expect the MPC to wait for the May Inflation Report before deciding on any further move. (Though it should be remembered they increased rates in January – much to many people’s surprise.)

Comment by Andrew Lilico
(Europe Economics)
Vote: Raise by ¼%
Bias: Raise further

The annual growth of M4 broad money continues just under 13%, and the recent three-monthly annualised growth rate of around 10% appears now revealed as a blip. Growth would have to be returning to a steady 10% or less before the monetary data ceased to speak for a rise. Given the very strong monetary growth of recent years, CPI at 2.8%, well above target for many months now, is no surprise. Indeed, RPI inflation at 4.6% and rising rapidly would surely already have provoked a more significant policy response under previous target regimes.On the other hand, there seems little in the way of countervailing real economy weakness. GDP growth has been, and is forecast to be, solid. Retail sales growth is robust. Unemployment is steady. Rates may need to be a half point higher, but my inclination would to raise by a quarter point now and think again next month.

Comment by Patrick Minford
(Cardiff Business School, Cardiff University)
Vote: Cut by ¼%
Bias: Further loosening

The situation in the world economy is now beginning to look overcast with problems emerging in the US housing market getting worse not better. The Fed is likely to respond slowly and a slowdown could well be fairly sharp - this delayed response will be both un-Greenspan-like and a mistake. Here the forecast inflation rate is for 2% by the second half of the year. A forward-looking strategy would imply the interest rate starting to be cut now.

Comment by Gordon Pepper
(Lombard Street Research and Cass Business School)
Vote: Raise by ½%
Bias: If rates are not raised immediately ½% may turn out to be insuficient.

In both January and February I advocated a ½% rise. I only refrained from doing so last month because of turbulence in financial markets. If the US market had continued its sharp fall, the timing of a ½% rise in UK rates would have been inappropriate. It seemed prudent to wait and see. Because the sharp fall in share prices has not continued a ½% rise in rates is now overdue.

Comment by Anne Sibert
(Birkbeck College)
Vote: Raise by ¼%
Bias: Then possibly hold in the medium term

An apparent lack of spare capacity in the UK economy suggests that there is little case for monetary easing. Recent wage settlements indicate that the risk of lower output and higher inflation arising from increased labour costs has diminished, somewhat reducing the case for increasing rates. However, the CPI, which had reached 3.0% in December, remained at 2.8% in February, making ten consecutive months that inflation has been above target. In the medium to longer run, inflation risks are probably on the upside. Recent financial market volatility reduced the case for an interest rate rise earlier this month, but a ¼ % rise seems appropriate now.

Comment by David B Smith
(University of Derby and Beacon Economic Forecasting)
Vote: Raise by ¼%.
Bias: Further tightening may be required

The convoluted tax jiggery pokery announced in the 21 March Budget makes it hard to see whether there are any monetary policy implications. The Budget measures appear to have been broadly neutral in Keynesian demand management terms, and the ONS have estimated that the indirect tax changes announced in the 2007 Budget added 0.19% to the CPI and 0.22% to the RPI, exactly the same as last year. However, a supply side analysis is less reassuring and suggests that the Budget measures may have reduced both the demand for labour - because of the shift of the corporation tax burden from large companies, which do not create jobs, to small ones that do – and also cut the supply of labour services, through the lifting of the ceiling on employees’ National Insurance Contributions. It is also probable that the extension of tax credits, to offset the abolition of the 10p tax band will reduce the work effort of people at the lower end of the earnings distribution. Lower paid single workers who do not qualify for tax credits, and older workers with good pension rights, may well wonder if it is worth working at all, at least in the formal economy.

The wider economic evidence suggests that a rate rise is now overdue, even if the Budget has not tightened the output gap through the supply side, and there seems little reason for delaying now that global stock markets have bounced back. Money and credit growth are clearly excessive, particularly when it is borne in mind that the shortfall of annual RPI inflation below output corrected M4 growth has been only 2% over the past four decades, suggesting that M4 growth of around 7% rather than its February rate of 12.8% would be consistent with a 2% CPI target. Sterling has recovered a bit recently, reaching 103.8 (January 2005=100) on 27 March, but this is probably not high enough to preclude a rate increase, while Britain’s endemic trade deficits also suggest that the UK economy is suffering from the symptoms of a suppressed inflation, in which an excessive growth of broad money is leaking overseas.

The main tactical issue is whether the MPC should wait until they have a new of Inflation Report forecasts available and delay rate tightening until 10 May. It is easy to sympathise with the Bank of England’s econometricians, who would naturally want rate changes to be informed by the output of the Bank of England Quarterly Model (BEQM). However, if headline inflation of 4.6%, and the fact that under the old RPIX targeting regime the Governor would have had to write two letters in the last three months, do not serve as a wake up call it is hard to see what will. The official Bank rate should be raised by ¼% on 5 April, and the authorities should be prepared to raise interest rates again if inflation does not start coming off rapidly from the summer onwards.

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 Chairman is Professor David B Smith (University of Derby and Beacon Economic Forecasting). Other current members of the Committee include: Professor Patrick Minford (Cardiff Business School, Cardiff University), Professor Tim Congdon (Visiting Fellow, London School of Economics), 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 and Non-Executive Director, Arbuthnot Banking Group). Professor Philip Booth (Cass Business School and IEA) is technically a non-voting IEA observer but is awarded a vote on occasion to ensure that nine votes are cast.


Comments

When I read this in The Times earlier today I honestly thought it might be an April Fools joke!

Posted by: Minh at April 1, 2007 10:42 AM

Why? Overwhelmingly, by something like 95%, City economists expect a rate rise in either April or May. The fact that this particular group of economists favours April shoild not be a huge surprise.

Posted by: David Smith at April 1, 2007 08:45 PM

Probably just being overly cautious because it is April Fool's Day, and 8-1 for a hike seemed surprisingly hawkish. Mind you, while the real MPC may be unwilling to upset the boss ahead of the local elections, the Shadow MPC obviously don't have to worry about that. That's the only reason I think that May could still be more likely - although they are announcing their May decision on polling day, are they not?

Posted by: Minh at April 1, 2007 08:59 PM
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