Wednesday, April 18, 2007
Three-way split on the MPC
Posted by David Smith at 10:00 AM
Category: Thoughts and responses

The minutes of the monetary policy committee's April meeting have been published and reveal a 7-2 vote for no change. Within this there was a three-way split, with Tim Besley and Andrew Sentance voting for an immediate hike, "some other members" preferring to wait, it seems, until May, and others not yet convinced of the need for a rise. That suggests two things, even in the wake of yesterday's inflation numbers. First, the May hike is highly likely to be a quarter, despite talk of a half-point. Second, it is unlikely to be carried unanimously. The minutes are here.


Dear David,
I was hoping for a 5-4 vote. Anyway, some of today's comments on the papers are slightly unfair to the MPC. The MPC sets interest rates with the aim of bringing inflation close to the 2% target in the medium term (i.e. two years ahead). To understand what went “wrong”, it will be helpful to go back to the February 2005 Inflation Report. The MPC’s central inflation projection for the first quarter of 2007 was 2.12%, whereas the market’s prediction was 2.15%. At the same time, the Inflation Report predicted a risk of lower than 2.12% inflation (the MPC calls this the "degree of skewness" or "balance of risks"). As a result, and rightly so, the then MPC decisions were to leave the base rate unchanged at 4.75%.

PS1 During those meetings, only Paul Tucker (who still serves) saw it coming and argued for an interest rate increase.
PS2 David Blanchflower only joined in June 2006 so he can not be blamed for the current 3.1% inflation rate (although it looks unlikely that he would have wanted an interest rate increase had he been a member of the MPC).

Costas Milas
Keele University

Posted by: Costas Milas at April 18, 2007 10:22 AM

Yes, I was expecting more than two votes for a hike. You are quite right to go back to where the MPC was a couple of years ago. The mistake, on that basis, was in August 2005, when the committee voted 5-4 for a cut, Mervyn King being in the minority against.

Posted by: David Smith at April 18, 2007 10:45 AM

I remember that 5-4 vote for a cut only too well - I was enraged.

Is there a political angle here? Seeing that half of the MPC are appointed directly by the MPC and that an IR rise now would be seen as politically damaging by the government.

Didn't Eddie George recently admit that the BoE had previously kept interest rates artificially low in an attempt to boost consumer spending?

I understand that he said that his legacy to the current MPC was to "sort out" the problems that this policy had caused.

All I'm seeing is inaction.

I've virtually given up having sane conversations with the agents I come into contact with - "We're seeing the housing market cooling," etc. ?????????????

Posted by: Lukenazeshradson at April 18, 2007 11:19 AM

Dohhhhh - that should be 'appointed by the Chancellor', not appointed by the MPC. Must improve my proof-checking. Sorry!

Posted by: Lukenazeshradson at April 18, 2007 11:20 AM

In a sense, most of the MPC is appointed by the government - the governor and his two deputies are government appointments, and the four external members are appointed by the chancellor. Since the latest two of these have been aggressive interest rate hawks, however, I think the political charge doesn't stick.

Posted by: David Smith at April 18, 2007 11:47 AM


I am a little confused as to why the Bank did not have the Inflation report before making the decision on Interest rates at the last meeting - normally they have an inside track on what will happen to Inflation don't they?



Posted by: Paul at April 18, 2007 12:52 PM

Just picked this up...

Average earnings including bonuses rose an annual 4.6 percent in the three months through February, the government said today, up from 4.2 percent.

Your take on this latest news would be welcome David.

Posted by: Lukenazeshradson at April 18, 2007 12:58 PM

Some months they have an advance on the inflation numbers, some months they do not, depending on the gap between their meeting and the publication of the figures. Easter ensured that this was one of the months when they did not have sight of the figures. There's a debate about whether advance knowledge would have changed their decision - the 3.1% number brought inflation for the first quarter bang into line with the Bank's last forecast, and the MPC would not want to be seen to be reacting to what's already happened i.e. a rate hike in April 2006 might affect inflation in March 2007; one in April 2007 clearly wouldn't.

Average earnings jumped because of City bonuses; the underlying picture - 3.6% - remained benign, and there was some evidence of a softer labour market in the data.

Posted by: David Smith at April 18, 2007 01:08 PM

Dear David,
I will converge to your predictions with another line of arguments. Being a mixture of academics and practitioners the MPC will discuss academic arguments.
a) The opportunistic approach (that is, the “wait and see” policy when inflation is close to the target followed by the vigorous response when inflation moves further away- a game played extensively by the MPC) suggests a 50 basis points increase. Some (including perhaps David Blanchflower), will object strongly to this. Such an increase has never been decided (since they first met in June 1997; interestingly, a 50 basis points reduction has been decided four times since then).
b) According to the second economic argument, the MPC should not respond to inflation when the latter is highly volatile and therefore very difficult to target (i.e. CPI inflation jumped from 3.0% in December down to 2.7% in January and then back up to 3.1%). Instead, the MPC should focus on output (which is currently growing above trend and seems to be less volatile than inflation) or make a decision which stays close to the most recent level of interest rate.
Both arguments point to a 25 basis point increase in May; apologies for the lengthy comment.

Posted by: Costas Milas at April 18, 2007 01:25 PM

Hi Costas

a) Blanchflower has lost a great deal of credibility in my opinion. It was reported in February that Blanchflower had predicted that inflation, which was running at 2.7 per cent in January, would hit the Bank's target by spring or early summer 2007 - and could be below that by the end of the year.

Luke Nazesh Radson

Posted by: Lukenazeshradson at April 18, 2007 02:10 PM

Well, the MPC still(?) thinks that inflation will be 2.06% in the last quarter of 2007. This is still likely as the current volatility suggests that inflation can jump either way. At the end of the day, what matters is the majority vote (with or without a letter..), rather than statements made by each one of them.

Posted by: Costas Milas at April 18, 2007 02:31 PM

The vote to cut in March was strange but, as you say, Blanchflower's quoted inflation view was that of the MPC. This from the governor's letter yesterday:
" At the time of the February Report ..... the central outlook was for inflation to fall to a little below the target by the end of this year."

Posted by: David Smith at April 18, 2007 02:42 PM

It is, of course, correct that interest rate changes only have their full effect over an 18 month to two year time frame. It is not, however, correct to think that they have no effect before this. Consider, if interest rates went up to 50% tomorrow, do you think it would be some time in 2009 before any effect was felt? Interest rate changes have some immediate effect, and the Bank's decisions of recent months could have affected yesterday's number.

In particular, the Bank's decisions since it itself said, in August 2006, that there was a 15-20% chance of inflation exceeding 3% (even after its August rise), could have had an effect. But the Bank chose to engage in only very limited action - just two quarter-point rises over a period of eight months. One can only conclude that it did not consider that it mattered very much whether inflation exceeded 3% and so wasn't something it was worth engaging in more significant policy action to avoid.

Posted by: Andrew Lilico at April 18, 2007 04:22 PM


Whilst going back two years, is ideal. The only problem is practically all the excess inflation is from domestic energy hikes last June, and the Tutition fee incease in Oct.

Without these the CPI would be on Target, and I can't see how the MPC could have anticipated either of these, or even raising interest rates would have stopped this.

OK, it might have made other items lower, but then they would be dropping out of the bottom of their range come June.

Frankily the MPC were on a hiding to nothing, when the huge domestic energy increases came through!

Posted by: Kingofnowhere at April 18, 2007 04:43 PM

I have to intervene - plans for a massive hike in tuition fees in 2006 were made public in 2003.

The white paper on higher education funding, published in January 2003, signalled the government's intention to allow universities to raise their fees to up to £3,000 a year.

If the MPC didn't anticipate the impact on inflation - well, what can I say.

Posted by: Lukenazeshradson at April 18, 2007 05:58 PM

And another snipped for you kingofnowhere...

'The inflation numbers we have seen so far [the core numbers which EXCLUDE energy] - for housing, producer and consumer prices - are all pushing higher so this has got to be enough reason for the bank to tighten rates in May,'
George Buckley, UK economist at Deutsche Bank

Posted by: lukenazeshradson at April 18, 2007 06:05 PM

And I'll come to his defence. The tuition fees announcement may have been some time ago but it was only during the course of 2006 (and quite late in 2006) that the ONS decided on their treatment within the CPI. Core inflation has risen, but it is below 2%.

Posted by: David Smith at April 18, 2007 06:13 PM

Hi David

That was my point entirely, if they had acted to keep the CPI at the 2% target, they would have needed an underlying rate (Excl Dom energy and tutition fees of about 0.8%, as dom energy and tut is adding about 1.2% at present)

When this falls out, dom energy (June), tut (Oct), then they would be under the CPI bottom range

They are only 0.1% above the range, and knowing that energy is going to fall out (they will be back to target by about June), which they have no control over, then I think the deserve a pat on the back, rather than "ohh they are failing, and they should have done something"

IMHO, we should be saying "well done"

Posted by: Kingofnowhere at April 19, 2007 08:23 AM

As Mervyn King pointed out, the fact that he had to write a letter when inflation breached 3.0% does not mean that the Bank has a target range of 1% to 3%. There is no range. The target is 2%. Inflation is now 55% over the target.

Where is the BoE/Treasury going to draw the line of what to include and not include in their inflation target? First houses and taxes. Then education. Now energy. Why not exclude everything, and then the BoE can pat themselves on the back all they want? Inflation will still be out of control.

Posted by: RichB at April 19, 2007 12:24 PM

One reason CPI has gone up of course, is because of higher taxes - petrol duties, air passenger duty, etc. Tuition fees are a kind of tax too.

Posted by: David Smith at April 19, 2007 12:37 PM


My point entirely. If the MPC now had inflation at 2%, then when Dom Energy price increases from last year drop out (and the MPC can't control the price of Dom energy), then they would have been below their target by more than 1%

The MPC (and the commentors), should see through this noise, and say "what could they have done about the 25% increase in Dome energy (3.9% wieghting), which is still adding 1% to the CPI.

This will fall out by June, and will be replaced by cuts (If the MPC are below target then Should they decrease interest rates?)

Posted by: Kingofnowhere at April 19, 2007 12:38 PM

So how big is my pay rise then ?

Posted by: assetpriceinflation at April 19, 2007 05:06 PM

Domestic electricity bills rose by 27% in 2006 and gas bills by 40%.

Now energy prices are coming down - British Gas recently announced gas price cuts of 17% and electricity price cuts of 11% from March 12, while nPower will cut gas prices by 16% and electricity prices by 3% from April 30.

Will the downward impact be quite as large as you're suggesting kingofnowhere?

It shouldn't be forgotten either that back in March (haven't looked at April figs, but probably even worse) over half of the 56 components of the consumer price index have inflation rates over 3%.

And when we look at M4 lending, much has been to other financial corporations - helping asset prices to boom, ultimately spilling over into service price inflation.

Posted by: lukenazeshradson at at April 19, 2007 10:03 PM

Lets not forget the inflationary impact of unsustainable house price increases either. The number of RICS surveyors reporting house price incrases is still at double the long term average of 12, supporting the strong numbers recently posted by the Nationwide and Halifax.

Posted by: lukenazeshradson at April 19, 2007 10:11 PM

Hi Luke

At present (March) domestic energy prices are up 25% YoY, they have a wieghting of 3.9% and so of the 3.1% they are adding 1% to the CPI.(With out this, the CPI woulld be 2.1) In JUne, the prices will be slightly lower than last year.

Therefore the 1% will fall out and be replaced by a small fall, the CPI will be falling soon and very fast, as last years increases fall out of the equation (Unless they choose to put up Dom enegy prices, which I don't thinks going to happen!

Posted by: kingofnowhere at April 20, 2007 09:09 AM

Central Banking: A deadly game of 'Cat and Mouse'

Dear David,

As Mervyn King has tolds us before, through the 'Maradonna IR Strategy', the rhetoric of central bankers is key to their credibility in the markets, right? The MPC doesn't want to be seen to make panic responses, so then surely at high levels of inflation it doesn't want to appear as if it is alarmingly bover'd...

However, now that we have seen exactly what an 'open letter' entails - a lukewarm commentary on the opinion of the MPC, with no vague traces of an apology for not doing one's job properly. Then surely in the future, the market will not be so sure that the MPC will avoid exceeding 3.0% inflation. Previously, the possibility of exceeding 3.0% and writing an open letter, smacked of failure and was possibly the harbinger of "resignations".

Now, post-letter, if the market doesn't think the MPC has a severe disincentive to fail, surely the MPC will lose some credibility. The rules of policy-making rhetoric have surely changed, and now is not the time for Mervyn King to be claiming that the MPC is continuing with its original forecasts, like a child that stubbornly refuses to learn his lesson. As suggested earlier, this must be the time for much more aggressive action a la Greenspan, rather than trying to mask failure.

Gordon needs to get his staff in line.

Posted by: Jonathan Blaze at April 20, 2007 12:41 PM

David - I posted a calculation about the rise of my parents' property in Sussex a few days back - here's a similar one from the guardian - seriously, things are hideously out of kilter



Through the roof: From £300 to £1m in 106 years

A vicar's widow bought this south London terrace house in 1901 from the developers, Prudential Assurance, for £300. In its first 50 years it went up in price just four times, but since 1983 it has gone up in price 50 times, with the most gravity-defying rises in the last six months alone. If it went on the market today, it would fetch £1m.

A Land Registry check on the property in Herne Hill, which has changed hands 14 times since 1901, confirms the scale of the recent boom, but also reveals how over the century prices in the capital have frequently stagnated or fallen.

At the first sale, in 1903, the house fetched £575, but by 1927 it had gone up to just £825 - a gain of only 1.1% a year over 24 years. Sold again in 1929, it fell back to £735. Four years later, in 1933, it was sold for £800, still below the price achieved six years earlier.

Helped by the postwar housing shortage, it sold for £1,740 in 1947, more than double the 1933 price. But as Londoners fled the peasoupers of the 1950s, the figure fell. In 1958 it sold for £1,500, a fall of 14% over 11 years.

Since then prices have boomed. In 1968, it changed hands for £6,200, a gain of 226%, and in 1983 was bought by builders for £20,000. They subdivided it into three flats, selling them in 1986 for a total of £133,000. The middle, two-bed flat fetched £52,000, and sold in 1999 for £141,500. In 2005 the flat sold for £250,000 and today local agents Hamptons International say it would market for £370,000. Hamptons sold a whole house in the terrace last month for £945,000.

Posted by: Jonathan at April 20, 2007 03:28 PM

I agree - we, the business community, have been far too quiet about house prices for far too long - most of us have been sitting back and watching our own equity increase, but now the flip-side is becoming all too apparent. Is it supply and demand? - well, yes, but that demand is fuelled by bank lending at insane income multiples, and sub-prime lending. Surely someone is getting the message about the need to regulate bank lending by now? House price inflation has only really started to have a negative impact on my business over the last 6 months (staff recruitment and retention - I'm starting to hear of similar probs within other SMEs).

Posted by: lukenazeshradson at April 20, 2007 08:27 PM

Kingofnowhere, when you talk about energy prices falling out of the CPI figures - “electricity, gas and other fuels” rose by 2.7% in March 2006, whereas in March this year it fell by 0.3% = 0.1 percentage point fall in CPI.

BUT a 2.5% rise in petrol prices in March 2007, which compared with a 0.1% fall in March 2006 = addition to CPI.

Meanwhile, the UK CPI food sub-index rose by 5.5% in the year to March.

Don't you think that petrol/food price increases will lessen the impact of any falls coming through from gas/electricity/heating oil price cuts?

Posted by: lukenazeshradson at April 21, 2007 04:19 PM