Sunday, January 19, 2020
A rate cut now would be a vote of no confidence
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

Things have taken an unexpected turn, which is always interesting. Financial markets have, in the space of a couple of weeks, gone from thinking that there is no chance of an interest rate cut this month to expecting one. January 30 will be the last interest rate decision presided over by Mark Carney as Bank of England governor.

Though he does not hand over to Andrew Bailey until March, who will be in place for the next monetary policy committee (MPC) meeting later that month, markets had expected his final meeting to be, in interest rate terms, a non-event.

That would not be unusual. Carney will, by my reckoning, have chaired 66 MPC meetings when he steps down and on only three occasions – once to cut, twice to raise – have interest rates been changed in that time.

Markets, however, see roughly a 60% chance of a cut at the end of this month. Are they right to expect it? And, as importantly, would the Bank be right to cut rates?
The weeks surrounding Christmas and New Year are traditionally fallow when it comes to new economic data, and harder than usual to interpret. Lord (Mervyn) King, Carney’s predecessor, once said that for retail sales, the true meaning of Christmas only became clear by Easter.

In its last meeting of 2019, on December 19, there were two votes to cut interest rates but the majority on the MPC, the seven voting for no change, declared that the existing stance – a Bank rate of 0.75% - was “appropriate”.

The economy was doing more or less as expected, they said, and while growth was expected to be “below potential” in the short term, it should “rise above it next spring, given the assumed combined support from lower uncertainty, easier fiscal policy and somewhat stronger global growth”.

The lower uncertainty refers to both the December 12 election result and the certainty of Brexit on January 31, while the spring will see the economy gain from Sajid Javid’s planned spending boost and the chancellor’s cut in National Insurance, achieved through raising the threshold at which it starts to be paid from £8,628 to £9,500.

The question for the majority, then, is what has changed over the past month. In terms of hard data, there has not been a lot. Monthly gross domestic product figures showed a 0.3% fall in November, alongside modest upward revisions in earlier months. They suggest that the economy is on course to have stagnated in the final quarter of 2019. Retail sales have done worse than stagnating, falling by 0.6% last month, and by 1% in the fourth quarter.

Inflation is also well below target, dropping to 1.3% in December, from 1.5% in October and November. But, given that the Bank was expecting a 1.4% average in the final quarter of last year, that will not have come as too much of a surprise.

“Soft” data, in the form of surveys, suggests that something is stirring, along the lines that the MPC majority expected. It began with the service sector purchasing managers’ index, an indicator which is set to be prominent again very soon. It showed a stronger reading than the earlier “flash” estimate, and suggested business confidence had been boosted the election result.

An even stronger finding was in the Deloitte survey of CFOs (chief financial officers), a week or so ago, it showed a sharp rebound in confidence and stronger expectations for investment and employment.

Perhaps most impressive of all was the latest RICS (Royal Institution of Chartered Surveyors) residential market survey. For those who do not follow it, I can tell you that the RICS survey has been downbeat for some time. But sales expectations picket up “noticeably” after the election, it said, as did enquiries from buyers and agents’ price expectations. Buyers and sellers are more confident.

If you were looking at the hard data, which is backward looking, and contrasting it with the survey data, some of which is forward looking, you might conclude that there is not much of a case for a rate cut.

The other ingredient, however, is what MPC members, particularly the so-called external members, have been saying. They are as aware of the data and the surveys as anybody.

One, Jonathan Haskel, said immediately after the last decision on rates that “current data justifies looser monetary policy” and feared that “Brexit uncertainties may remain entrenched”. More recently Gertjan Vlieghe said that he needed to see “an imminent and significant improvement in the UK data to justify waiting a bit longer”. Another external member, Silvana Tenreyro, said : “If uncertainty over the future trading arrangement or subdued global growth continue to weigh on demand, then my inclination is towards voting for a cut in Bank rate in the near term.”

Carney has conceded that “there is a debate at the MPC over the relative merits of near term stimulus to reinforce the expected recovery in UK growth and inflation”.

Perhaps the best argument for a cut came from Michael Saunders, another external member, and like Haskel a cutter in November and December, in a speech a few days ago. He knows the surveys like the back of his hand, having analysed them in great detail, as a City economist. Despite them, he thinks growth will stay sluggish – the economy he says has a “slow puncture” (a phrase used here last month) and inflation will remain below target.

The case for acting now, he argues from a “risk management” perspective, is because the Bank has limited ammunition. If very slow growth becomes ingrained, and the economy is locked into a “self-perpetuation low inflation trap” then there is not that much, in cutting rates that could be done to lift it out of it, or worse, lift it out of recession. Better to act quickly, he argued, even if it means raising rates again in a year’s time should the cut have proved unnecessary.

It is a good argument, though the counter to it might be that if you have limited ammunition it might be better to hang on to it until the need is more obviously pressing.

So let me answer the questions I set myself. Will the Bank cut rates on January 30? Rightly or wrongly, the “flash” purchasing managers’ index (PMI) this Friday will be pivotal. Weak PMIs led the Bank to cut rates in the immediate aftermath of the EU referendum 3½ years ago. Without knowing those it is impossible to say with certainty but I would put the chances of a cut as closer to 50-50 rather than the 60%-plus the markets were suggesting last week.

Should the Bank be cutting rates this month? I would say on balance no, though I sympathise with the idea that the Brexit drag on the economy will persist. The surveys may be telling us nothing more than that businesses and consumers are relieved that we did not get a Labour government led by Jeremy Corbyn last month but they deserve time. Time means that we should wait for some hard data on what the economy has actually been doing this year, rather than rely on late 2019 readings. Waiting until March, and the new governor, would do nobody any harm. Cutting now would be a vote of no confidence in the economy.