Never one to pass up the opportunity of employing a useful cliché, I have lost count of the times I have used “a year of two halves” to describe the preceding 12 months. But now, just when I have worn it out, the expression seems more apt than ever.

Cast your mind back to the first half of the year, and the exuberance was tangible. Every day, it seemed, there was a new private-equity deal. The economy was booming and so were house prices. The governor of the Bank of England was forced to write an open letter explaining why inflation had risen above 3%. He and the rest of the monetary policy committee (MPC), desperate to control this bucking bronco of an economy, raised interest rates from 4.5% to 5.75% and promised more. The last of those increases came, appropriately enough, in early July, just after the middle of the year.

Then the wind changed. It was not quite a Michael Fish moment for King, but his insistence on August 8 that there was no international financial crisis was followed on August 9 by the equivalent of a hurricane in the money markets.

Since then, of course, it has been a question of watching and waiting. Most of the economic data, it should be said, have continued on the strong side, including perky figures for November retail sales on both sides of the Atlantic. But the surveys have suggested weaker growth ahead and so has a sharp drop in business and consumer confidence. The housing market has been notably weak and appears to have felt the impact of the credit crunch most intensely, coupled as it was with the introduction of home information packs (Hips).

At first it seemed as though the eye of the storm had passed quickly, and money markets began to return to normal in October. But a second gust followed, to which central banks were obliged to respond.

So who got the economy right? The answer, in important respects, is nobody. There were people who worried about losses on sub-prime lending in the United States. There were those who were concerned that the Bank and other central banks were raising rates more than was necessary. I drew the line at the last of the MPC’s rate hikes.

But nobody, to my knowledge, predicted that the sub-prime crisis would spread as it did, forcing central banks into unprecedented action to support the markets, forcing some of them to reverse previous rate rises and forcing Northern Rock into the unwilling arms of the Bank of England. The story of the economy in 2007 was not in the numbers but in the drama of real-life events.

In terms of the numbers, forecasters were too downbeat about Britain’s growth prospects this year, something to bear in mind perhaps when assessing some of the direr warnings for 2008. Economists did better on inflation, predicting it would get back to 2%, having been above it.

Even so, the consensus was that the Bank would not have to raise rates as much as it did. Most Bank rate forecasts for the year-end were clustered around 5%. Unemployment was expected to rise rather than fall.

The recent bombshell announcement from the Office for National Statistics that the current-account deficit in the third quarter was £20 billion also ruined quite a few forecasts. Although the numbers will probably be revised, it is hard at present to come up with a number of less than £60 billion for the full-year deficit for 2007. That is a lot of red ink, roughly double the average forecast made at the beginning of the year.

It is an ill wind, however, that blows nobody any good. The only economist who got close to my guess for what would happen to the balance of payments deficit was Michael Saunders of Citi, who predicted £56.9 billion.

Saunders, a previous winner of my annual forecasting competition, was also more optimistic than most on growth (2.9%), close on inflation (2%), and predicted a fourth-quarter Bank rate average of 5.4%. The only one he got wrong was unemployment. But a score of 9 out of 10 was a very creditable performance, and he deservedly tops the table again.

Speaking of 2008, he said recently: “The UK has probably been the fastest growing country in the G7 this year but is likely to have the sharpest slowdown among G7 countries in 2008.”

Congratulations also to Peter Spencer at the Ernst & Young Item Club, and to JP Morgan and the others who got close. (For the full table, see the print edition of The Sunday Times).

How did I do? I was a little too low on growth, 2.6%, and thus too high on unemployment, 1m; okay on inflation, 2%, but my prediction of a £40 billion current-account deficit was not gloomy enough. I suggested Bank rate might rise and fall, but to 5.5% and 5% respectively. I would have scored seven out of 10.

I am always accused of being too optimistic about house prices, but this year, as for the past couple of years, the rise exceeded my expectations, certainly in the early part of the year. I thought house prices would rise 5% in 2007 as a whole, with most of the strength concentrated in the first half. That will not be too far out but is probably still a little on the low side.

In looking at the forecasting record for 2007, however, I also have to give a large bouquet to the Treasury. It can never get top marks in my forecasting league table because it does not make predictions of interest rates (because this would be seen as second-guessing the Bank) or unemployment (because it could be politically difficult openly to predict a rise).

But in a year when every independent forecaster was too gloomy about growth, the Treasury’s optimism came good, having the only forecast (2.75% to 3.25%) with a three in front of it. By sticking with its convention of predicting that inflation will always gravitate towards the government’s 2% target, the Treasury got that one right, too.

For 2008 the Treasury is expecting 2% to 2.5% growth and, as before, 2% inflation, on the optimistic side of the consensus. Let us see if its luck lasts. More next week on the 2008 outlook and the chances of a Bank rate cut in January.

PS: I hope that those who have not already done so are beavering away on the Christmas quiz, published here last week, and available online for those who missed it. In the meantime, let me offer you an end-of-year insight into the most popular subjects in this column, as defined by the response from readers.

Keep the responses coming.

From The Sunday Times, December 30 2007

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How much more gloom can you take? How much worse can it get? Bad news sells, so perhaps I should be laying it on with a trowel, frightening you into submission well before you get to the end of this piece.

Not only do we have the credit crisis but a record balance-of- payments deficit, the budget deficit is overshooting and the pound has fallen. Even the normally staid monetary policy committee (MPC) has warned that a "substantial loosening" — big interest-rate cuts — might be needed.

David Owen, an economist with Dresdner Kleinwort, thinks that with the latest data there is now a 50:50 chance of a "technical recession" next year — two consecutive quarters of declining gross-domestic product. That has not happened for 16 years.

Perhaps, however, it is time to take a more optimistic view, this being the season to be cheerful. Gordon Brown and Alistair Darling are as confident in private as they are in public that Britain's economy is strong enough to pull through this. And, while it is easy to see the prime minister and chancellor's optimism as self-serving — they will suffer most if things turn out badly — they have some support on their side.

Every month the Treasury puts together a compilation of independent forecasts. The latest, published a few days ago, shows economists expect a slowdown but not a recession.

Four months after the credit crisis broke, the average growth forecast for 2008 is 1.9%. That is slow but not painfully so, and slightly better than 2005, when Britain managed only 1.8% growth.

True, there is one forecast of outright recession, with Peter Warburton of Economic Perspectives expecting the economy to contract by 0.1%. He, however, is balanced by the optimists at MacroEcon.com, who predict 3% growth. Most forecasts are clustered around 2%.

There are, of course, any number of jokes about economic forecasters, sometimes involving unfavourable comparisons with meteorologists, but they will have collectively made a huge error if the economy were to be badly derailed next year.

Britain's long run of growth, stretching back to April-June of 1992, represents a lot of momentum. Annual growth in the third quarter of this year was a buoyant 3.3%, and more if you believe the Bank of England, which thinks the official figures understate it. The brakes may now be on, particularly because of the credit crisis, but this is an economy that will take a bit of stopping.

Related to this, the labour market remains very healthy. Darling and Brown were guilty of opportunism in citing the unemployment claimant count, now at a 32-year low of 813,000, or 2.5% of the workforce. The government's preferred measure (or at least it used to be) has unemployment at 1.64m, or 5.3%.

Even so, unemployment has been falling and employment is a record 29.3m, up by 226,000 over the past year, with little or no help from the public sector. Jobs growth will soften soon but will do so from a very strong position.

The labour market is also relevant to the current benign inflation position, pay growth having remained subdued in the face of provocation. Last week's figures, showing consumer-price inflation steady at 2.1% in November, and slight rises in both RPI (retail prices index) measures, were better than expected.

They show the main inflation impetus is coming from rising energy and food prices, not generalised inflationary pressures. Inflation is still inflation, and the prospect is of some rise in the short term. But the broad picture we have is that upward pressures from the commodity markets are being offset by price cuts elsewhere. Retailers are discounting deeply.

Another big positive, for me, was last week's minutes from the MPC and the news of a 9-0 vote to cut Bank rate earlier this month. The lesson of the past 10 years has been that when the committee has been both flexible and united, it has usually done the right thing. That was the case in the autumn of 1998, when a different kind of financial crisis hit global financial markets. It was also true after the September 11 attacks on America.

There is an issue of whether the Bank can wrest control of interest rates back from the markets, the credit crisis and the scramble for liquidity having temporarily shifted the relationship between what the MPC does and the various Libor (London interbank-offered rate) maturities. But the evidence on this too has been encouraging in recent days, following concerted liquidity injections by central banks, including the Bank of England.

I am not pretending everything is rosy. The "twin deficits" — budget and current account — need fixing. Though I shall hazard a guess in two weeks' time, nobody can tell exactly how the credit crisis will pan out, how long it will last, and how permanent will be the change in lending behaviour.

But too many people use the excuse of the credit crisis to throw the baby out with the bathwater. If you believe there is nothing else to the economic success of the past 15 years than rising debt and a big increase in house prices, fine, but it is hard to substantiate that with serious analysis.

If you believe that a big, 10%-15% fall in house prices (which I don't expect) would take us back to the negative equity of the early 1990s, and leave banks with dodgy mortgage books, fine, but it is not true. As Goldman Sachs points out, housing turnover in the final phase of the boom was 40% lower than in the late 1980s. Loan-to-value ratios have been kept under control, so mortgage books are insulated from quite a big fall in prices.

It is possible, indeed, that the impact of the credit crisis will be beneficial, removing some of the froth and encouraging more responsible behaviour in future.

A complete collapse in business and consumer confidence and a self-feeding downturn is the gloomy alternative. Britain's consumers and businesses are, however, usually made of sterner stuff than that. Unless this is the start of a never-ending credit crunch, we should temper some of the gloom with a bit of optimism.

PS: The economy may rise and fall but some traditions have to be maintained. I am talking, of course, about the annual Economic Outlook Christmas quiz. I can't quite match last year's triumph — the opening lines of pop songs with economics or money as their theme (though I have a couple of those).

There is, as I say, a choice of tie-breakers. One is to come up with a better name for the credit crisis, which I am a bit tired of. The other is a new name for Northern Rock. Good luck.

From The Sunday Times, December 23 2007

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A veritable feast of data, worth looking at on the ONS website - growth in the third quarter was 3.3%, but the saving ratio fell to 3.4% and there was a £20 billion current account deficit. These figures are subject to revision but they are some way from the rebalancing we have been looking for. Meanwhile, the public finances suggest Alistair Darling is heading for a substantial borrowing overshoot.

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The decision to cut Bank rate from 5.75% to 5.5% earlier this month was, after all, clear cut. All nine members, including the hawks, voted to do it. Financial market conditions had deteriorated, they said, and the medium-term downward risks to both growth and inflation outweighed upward pressures in the short term. Hard to argue with that. The details are here.

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The inflation figures were good, CPI inflation holding steady at 2.1%, despite a surge in petrol prices. Both RPI measures ticked up slightly, RPIX from 3.1% to 3.2% and headline RPI from 4.2% to 4.3%. But the figures were a lot better than they might have been. Details here.

More significant, perhaps, the Treasury extended its guarantee to Northern Rock "at the request of Northern Rock plc, to ... unsubordinated wholesale obligations, whether now existing or arising in the future". The taxpayers' interest in a successful resolution to this affair has just increased. This is the Treasury's statement.

Meanwhile, the Bank conducted its first operation to supply additional liquidity, while Mervyn King hinted that nationalisation is now running ahead of a private sale as the most likely outcome. This is his opening statement to the Treasury committee.

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As everybody who has filled up recently knows, petrol and diesel prices have risen and are staying up. The £1 a litre “barrier” was breached easily.

High oil prices contributed significantly to a 3.4% jump in manufacturers’ input costs last month, a 10.3% rise on a year earlier. Petrol was instrumental in pushing “factory-gate” inflation to a 16-year high of 4.5%. There will be more of this on Tuesday in the latest figures for retail and consumer price inflation.

Oil did not quite make it to $100 a barrel and, for a few days dropped below $90. But last week’s coordinated action by central banks pushed prices back above $90.

So the surge in prices in recent months has revived a familiar question. Is it because oil is starting to run out? Have we reached, or passed, the peak in world oil production?

A new film just out in Britain, A Crude Awakening: The Oil Crash, begins with a sombre Philip Glass soundtrack. Its opening line, “Oil is the excrement of the devil”, tells you where it is coming from. It outlines a vision of a world beyond oil and “how our civilisation’s addiction to oil puts it on a collision course with geology”.

Peak oil is a broad church. To be fair to A Crude Awakening, it is hard to argue too much with the definition on its website. “Peak oil doesn’t mean ‘running out of oil’, but rather ‘running out of cheap and plentiful oil’,” it says. The film is directed mainly at an American audience, profligate in its oil use.

But what about the peak-oil “ultras”, who claim world oil production has reached or passed the summit? It has such a widespread following on the internet that surely it must be true. Actually, it is wrong.

The “peak oil has already happened” argument was partly based on the fact that global oil production, on International Energy Agency figures, had never been higher than the 86.13m barrels a day of July 2006.

That, however, is no longer true. World oil output in October was 86.5m barrels a day, 1m more than in October last year and 3m more than in October 2005. It edged up to 86.55m last month.

Even if it was the case that global oil production had been flat over the past couple of years, however, it would prove very little.

Why? During this time the Organisation of Petroleum Exporting Countries (Opec) cut output and only recently started to increase exports again. Less than five years ago Opec was happy with an oil price in the $22-$28 a barrel range. Now it is content with $90. Opec increased output quotas by 500,000 barrels a day this autumn but refused to do so again earlier this month.

Production in many oil-producing countries is constrained, not by geology but by politics. Iraq is producing only two-thirds what it did on the eve of the first Gulf war in 1990. That was no golden age, production running below potential because of weak investment during the Saddam era. Iran is producing well below potential.

The most important reason for rejecting the “peak oil is here” argument, however, is that current production reflects investment decisions taken years ago, when prices were much lower. It was only just over three years ago that oil rose above $40 a barrel. A few years earlier it was $10-$11. Higher prices will bring more output on stream. A new study by Germany’s Energy Watch Group, which said the peak was in 2006, makes the astonishing admission that it took no account of prices.

There is a long history of crying wolf on peak oil, dating back to the 1920s. The patron saint of peak oil, the geophysicist M King Hubbert, predicted in 1956 that oil output from the lower 48 states in America would peak around 1970 and he was right. He also predicted global production would peak in about 1990 and he was wrong.

Colin Campbell, founder of the Association for the Study of Peak Oil and Gas, first called the oil peak in 1990 and then at regular intervals. His view today is that a peak remains imminent.

Peak-oil people get excited about the giant Ghawar field in Saudi Arabia because it is apparently producing water rather than oil. The Ghawar “water cut” has reached 30% and bestselling books have been written on its imminent eclipse.

But, as Michael Lynch, peak-oil sceptic and president of the consultancy Strategic Energy & Economic Research, points out in a paper, Crop Circles in the Desert, this is a low figure. The average water cut throughout the industry is much higher, at 75%. The Ghawar cut rises and falls but the field still churns out 5m barrels a day, even at the age of 50.

Lynch is dismissive of another argument, that no big oilfields are being discovered. That, he said, is the nature of the industry – big fields are easier to find and smaller satellite fields around them come later. Large areas with the oil potential of, for example, Saudi, have not yet been fully explored.

There is, then, plenty of oil in the tank. Opec says additions to recoverable reserves since the early 1980s have been three times cumulative output over the period.

So why are prices so high? I have been taken by surprise and so have the oil bulls. A couple of years ago Goldman Sachs came out with a bullish forecast that the price would average $60 over five years. Today that looks conservative.

Oil is expensive because of geopolitical uncertainty, strong demand from the global economic boom of the past few years and speculative investment. Opec, which has most of the reserves, is happy to extract money from consumers to fund spending programmes. Most oil is in places we would not want it to be.

Demand has responded to higher prices, but not enough. The International Energy Agency’s worry is not that oil has reached a peak – it expects a 50% rise by 2030 – but that demand will rise faster than supply. We will see how much impact next year’s economic slowdown has.

Sheikh Yamani, the former Saudi oil minister, famously said the stone age did not end because the world ran out of stones. How will the oil age end? In a speech to mark the bicentenary of the Geological Society, “Peak Oil – a metaphor for anxiety”, BP’s Michael Daly predicted that we would be debating when the oil might run out in 100 years’ time. Long before then, thanks to high prices, alternative energy sources, climate concerns and technological advances, we will have probably passed the peak – but for oil demand rather than supply.

PS The concerted action by central banks to ease money market pressures is covered elsewhere [newspaper edition] but two views are emerging both on this and on interest rate cuts, including this month's from the Bank of England.

They also fail to understand the process through which monetary policy affects inflation – through demand. If inflation were very high you might need a recession to get it out of the system. That is plainly not the case now.

From The Sunday Times, December 16 2007

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The public believes that inflation is running at 3.2% and will be 3% over the coming year, according to the Bank of England's latest inflation attitudes survey. Both figures are the highest since the Bank started monitoring such attitudes, and probably reflect rising energy and food prices. It is still the case that inflation expectations are relatively low, lodged some way between the CPI and RPI. Details here.

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The major central banks have announced significant steps to try to address funding pressures in the money markets. Markets have responded favourable. This is the start of the Bank of England's statement:

Today, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, and the Swiss National Bank are announcing measures designed to address elevated pressures in short-term funding markets.

The Bank of England has already scheduled long-term repo open market operations (OMOs) on 18 December and 15 January. In those operations reserves will, as usual, be offered at 3, 6, 9 and 12-month maturities against the Bank’s published list of eligible collateral. But the total amount of reserves offered at the 3-month maturity will be expanded and the range of collateral accepted for funds advanced at this maturity will be widened.

The total size of reserves offered in the operations on 18 December and on 15 January will be raised from £2.85 billion to £11.35 billion, of which £10bn will be offered at the 3-month maturity.

The full statement is here.

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The outlook for 2008 may be uncertain but so far the job market is holding up well and earnings growth remains subdued. The claimant count dropped by 11,100 last month, while the Labour Force Survey measure dipped by 15,000 in the three months to October. Employment rose by 114,000 over the quarter. Earnings growth, meanwhile, dipped from 4.1% to 4% including bonuses, and from 3.7% to 3.6% excluding bonuses. Details here.

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The pebble I started rolling down the hill this time last week, calling for an interest-rate cut by the Bank of England, had turned into a boulder by Thursday lunchtime. The noise was deafening. Some say monetary policy is dull. Not these days.

The Bank, when it cut from 5.75% to 5.5%, was in tune with outside opinion. As well as the shadow monetary policy committee (MPC), which meets under the auspices of the Institute of Economic Affairs and whose deliberations are first reported here, the Times MPC voted for a cut. So did the Cazenove MPC, an in-house group run by our most blue-blooded of stockbrokers. There may be other MPCs out there I do not know about.

The Organisation for Economic Co-operation and Development, in its end-of-year economic outlook, revealed that it had factored in a December rate cut. Short of the Queen raising a 5.5% flag over Buckingham Palace, this is the nearest thing you get to an official endorsement.

The OECD, by the way, predicts 2% growth next year. One interesting feature of its forecast is that it thinks the saving ratio will decline further, from 3.3% to 2.7%, suggesting recent scares will not lead to an outbreak of household prudence. Both the Treasury and the Bank expect the ratio to rise.

Anyway, the weight of opinion favoured a cut, providing the Bank with an alibi if things go wrong. That, it seems to me, is unlikely. By the time the committee met, the case for a cut was overwhelming, though a good half of City economists did not expect it. We will see how overwhelming it was when the minutes are published in 10 days. It will be interesting to see if this was an occasion when the governor, Mervyn King, allowed himself to be outvoted.

Some commentators said that whether or not the Bank cut rates last week was a matter of life or death. I am tempted to adapt the legendary saying of the late Bill Shankly, former Liverpool manager, and say that it was much more important than that.

In time-honoured newspaper fashion, I had done the preparatory work for two columns this week, the one you are reading and a far more critical one. Had the MPC not cut, I would have concluded that this was a bad end to a bad year for the Bank. Happily, that one will never see the light of day.

In the grand scheme of things, whether the cut came last week or early next year probably does not matter hugely. The signal the Bank gave was, however, quite important at a time of rapidly weakening business and consumer confidence. To have remained aloof when the case for cutting was so strong could have given us a grimmer winter than necessary and increased the extent of the cuts needed next year. Sometimes the Bank has to show that it is responsive; that it cares.

As it was, this was a timely flu jab for the economy, and we can look forward to at least a couple more booster injections in 2008, with the next likely in February.

There will be those who say that the cut was all about rescuing the housing market. But the MPC, its evidence buttressed by the reports from its regional agents, was much more concerned about a broader-based slowdown in consumer and business spending that it thinks is unwinding. The economy is not falling off a cliff but it is slowing at least as sharply as the Bank expected in its inflation report last month.

As importantly, MPC members were concerned about the impact of what they described as a deterioration in conditions in financial markets and a tightening of credit availability. They do not use the word crisis, but we can.

As I said last week, when money- market interest rates are a percentage point above Bank rate, there has been an unintended tightening of policy. Fears the rate cut would not be passed on due to money-market turbulence appear unfounded. Both Halifax and Nationwide announced immediate, and matching, mortgage-rate cuts.

Has the Bank taken its eye off the inflation ball? A slowing economy will ease domestically generated inflation pressures (I exclude price rises that are "administered", such as rail fares, or emanate from the public sector). In the case of energy and food, a slowing world economy is what is needed.

The recent fall in oil prices from $99 a barrel to about $90 is partly based on expectations of slower global economic growth, which is why the Organisation of Petroleum Exporting Countries chose not to raise output last week. Other commodities are off their highs, in some cases significantly so. These markets are volatile but are no longer pointing relentlessly upwards and the Bank's rationale, that slower growth will ease inflationary pressures, was correct.

Finally, how weak is the housing market? Very weak indeed, according to Halifax, Britain's biggest mortgage lender, with prices down by 2.4% in the latest three months, equivalent to a near-10% annualised fall.

That compares, curiously, with a 1.5% rise by Nationwide over the same period. The Halifax series can be a bit volatile, though the bank, now HBOS (Halifax Bank of Scotland), said it had detected nothing odd in the numbers.

House prices on its measure started weakening back in September before they really should have done based on past relationships between prices, mortgage approvals and the Royal Institution of Chartered Surveyors' polls of its members. September was also probably too soon for a significant Northern Rock effect on market confidence.

So, while the housing market is undoubtedly weak, Halifax is probably overstating it. And, despite the weakness, Martin Ellis, its chief economist, expects prices to be flat next year.

Some will say mortgage lenders never predict house-price falls, but they do. In 2004, Halifax predicted a 2% fall for 2005 and, going further back, it had a 1989 forecast of a 10% drop in prices during 1990. On both occasions it was too gloomy — prices rose.

Whether it is too gloomy or too optimistic this time depends, first, on the Bank's willingness to show more of Thursday's flexibility on rates and, second, on the duration and severity of the credit crisis. But the Bank has made a good start.

PS: Tesco made an interesting excursion into the macroeconomic debate last week. When issuing its third-quarter results, Britain's biggest retailer, which accounts for nearly a third of supermarket sales, poured scorn on the idea that fast-rising food prices posed a serious inflation threat.

How does Tesco do it? Through a combination of efficiency and negotiating deals with suppliers — as some of them know only too well — the company claims. Whatever the cause, the task of Mervyn King and his colleagues would be a lot easier if we had Tesco-style inflation throughout the economy.

From The Sunday Times, December 9 2007

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The FT-Acadametrics house price index has been published and, partly due to the fact that it reflects prices at a different stage of the buying cycle, presents a different picture to other measures. The highlights:

* On a monthly basis, house prices in England and Wales rose by 0.5% in November, down from 0.7% in the previous month.

* On an annual basis, prices increased by 9.1%, down from 10.2% in June and the lowest annual growth rate since January.

* London remains completely out of step with the rest of England and Wales, with an annual growth rate of 18.5% (averaged over the last three months) which is nearly double the next highest region.

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The monetary policy committee cut Bank rate from 5.75% to 5.5%, the first reduction for more than two years. This is its statement:

"The Bank of England’s Monetary Policy Committee today voted to reduce the official Bank Rate paid on commercial bank reserves by 0.25 percentage points to 5.5%.

"Although output in the United Kingdom has expanded at a brisk pace for the past two years, there are now signs that growth has begun to slow. Forward-looking surveys of households and businesses suggest spending is moderating, broadly in line with the projections contained in the November Inflation Report. But conditions in financial markets have deteriorated and a tightening in the supply of credit to households and businesses is in train, posing downside risks to the outlook for both output and inflation further ahead.

"CPI inflation was 2.1% in October. Higher energy and food prices are expected to keep inflation above the target in the short term. Although upside risks to inflation remain, which the Committee will continue to monitor carefully, slowing demand growth should ease the pressures on supply capacity, bringing inflation back to target in the medium term.

"Against that background, the Committee judged that a decrease in Bank Rate of 0.25 percentage points to 5.5% was necessary to meet the 2% target for CPI inflation in the medium term."

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The Halifax recorded a 1.1% drop in house prices last month, confirming that November was a very weak month for the market and that the credit crisis is biting hard. It was its third consecutive monthly drop, the first since 1995, and makes the Halifax easily the gloomiest of the main house-price measures. It shows a 2.4% fall over the latest three months compared with a 1.5% rise for the Nationwide. Taking both together, November was bad on all measures and prices are clearly softening. We'll head down over the winter to zero annual house-price inflation.

Taken together with the service-sector purchasing managers' index, which was at its weakest since 2003, there is mounting pressure on the Bank to cut rates tomorrow.

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December is not normally a month when the Bank of England sets the world alight. Only once in 10 years of independence has it changed interest rates in the run-up to Christmas.

It would be wrong to say members of the monetary policy committee (MPC) are too busy carousing at this time of year to think about altering rates but something stays their hand. Will this December - this Thursday - be any different?

One straw in the wind is that the only December cut was when world financial markets were gripped by crisis, in 1998 when the Asian, Russian and Long Term Capital Management hedge fund crises came together. The credit crisis that exploded on to the scene this August is still with us and has further to run.

Not only that but a sudden shift of opinion has occurred on the “shadow” MPC, which meets under the auspices of the Institute of Economic Affairs. The shadow committee is not given to wild swings.

Last month it voted unanimously to leave Bank rate unchanged at 5.75%, arguing there was insufficient evidence of a credit crisis impact on the economy. This month, five of its members vote to cut, and not just by a quarter of a point.

Thus, Tim Congdon of the London School of Economics, emphasising the need for the Bank to restore normality in the banking system, says there should be a half-point cut.

He is joined by Peter Spencer of the Ernst & Young Item club, who is particularly concerned about the rise in Libor (the London interbank offered rate), back above 6.5% last week, and its impact on small and medium-sized firms.

The third half-pointer is Peter Warburton of Economic Perspectives, who is concerned about Britain’s exposure to the global credit squeeze, and thinks the Bank will have to cut to 4.5% during 2008.

Even these three are outdone by Patrick Minford of the Cardiff Business School. “It is time for some sense to prevail,” he says. “Rates need to be cut by 75 basis points at once to stabilise a fast-deteriorating situation.”

Strong stuff. The four are buttressed by John Greenwood of Invesco Asset Management, who opts for a quarter-point cut at this stage but notes that the credit “crunch” (there’s still a debate about whether this is a crisis, squeeze or crunch) has dramatically changed the UK outlook.

What about the four non-cutters? Two, Ruth Lea of Arbuthnot and Trevor Williams of Lloyds-TSB, have a “bias to ease”, meaning they will be ready to reduce rates but not quite yet. Andrew Lilico of Europe Economics, is neutral. My near namesake David B.Smith, thinks Bank rate may yet have to move higher. It is a broad church, the shadow MPC.

It is not be ignored and has a good record of predicting decisions of the actual MPC. What have we been hearing from the real thing? Two members, David “Danny” Blanchflower and Sir John Gieve, a deputy governor, are already in the rate-cutting camp.

Their view is that if Bank rate is to fall, as last month’s inflation report signalled, why hang about? They also think 5.75% is above the “neutral” rate, and implies policy is restrictive.

Gieve, with his responsibities for financial stability. is closer to the credit crisis than most MPC members. Blanchflower, who spends half his month at Dartmouth College, New Hampshire, is closer to the US economy. Goldman Sachs now sees a 40% to 45% probability of a stateside recession.

Of the others we have heard from in recent days, Mervyn King, Charlie Bean, chief economist, Rachel Lomax, the other deputy governor, it has been hard to detect anything that hints at an imminent cut. Tim Besley and Andrew Sentance, the MPC’s uber hawks, appear unbending.

Sentance said in a speech that the Bank was having to cope with two “shocks”; the downward impact of the credit crisis on growth prospects and the upward impact of higher oil and food prices on inflation. Oil prices have retreated a bit but not enough to resolve his or the Bank’s dilemma.

Lomax also put a bit of a dampener on things on a visit to Hull - a place that would benefit from cheering up - when she said the rate cuts implied in the Bank’s inflation report last month were “projections not promises”.

MPC members are good at playing their cards close to their chests. We have not heard from Paul Tucker or Kate Barker, who could be ready to cut. But the position, as things stand, is that none of the seven members who voted to hold Bank rate at 5.75% last month have even hinted they are ready to join the two cutters. This week’s decision will go the wire.

What should the Bank do? I have been cautious about calling for rate cuts in the wake of the credit crisis, for two reasons. One was the possibility, though perhaps not the likelihood, that the crisis would pass quickly. The other was lack of firm information on the impact of the crisis on the economy.

The first objection is fading. If we take three-month Libor as a guide, between early October and mid-November it hovered within half a point of Bank rate - not normal but not painfully high either. Now, it appears to be heading back to a percentage point above Bank rate.

Some of this reflects the end-year scramble for liquidity by the banks, which the Bank is trying to address, but it is also a reflection of the wider credit malaise. As long as Libor is at elevated levels, the Bank is presiding over an additional tightening of monetary policy it did not intend and the economy does not need.

On the second point, evidence is starting to accumulate of an economic effect. Growth was revised lower in the third quarter and business investment was flat. Consumer and business confidence are weak. Housing market activity has tailed off sharply, with prices down 0.8% last month according to the Nationwide (though after a 1.1% rise in October) and mortgage approvals at their lowest for nearly three years.

The Bank has to be forward-looking. If growth slows sharply, inflationary pressures will ease. That is why the time has come for the MPC to start reversing some of this year’s rate hikes. I opposed the quarter-point hike from 5.5% to 5.75% in July so let me start by calling, not for half or three-quarters like some members of the shadow MPC, but just a quarter-point cut.

Will it happen? Only members of the MPC know, and some of them have not yet made up their minds. Despite Lomax’s caution, rates are coming down. The only question is one of timing.

PS Scottish devolution has brought out a lot of strangeness. The other day I was watching an edition of BBC Question Time from north of the border - I know I shouldn’t - and several panellists were claiming it is nonsense to say Scotland gets more than its fair share of public money because government spending per head is higher in London.

This is also the case for my second prizewinner, Jeremy Kent-Baguley, who says there was an increase in marriage rates in America, and a decline in infidelity, after the film Fatal Attraction. Nobody, it seemed, wanted to risk getting on the wrong side of a potential bunny boiler. Thanks for all suggestions.

From The Sunday Times, December 2 2007

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The outcome of the latest Shadow Monetary Policy Committee (SMPC) monthly E-Mail Poll (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 6 December.

On this occasion, four SMPC members voted to leave Bank Rate unchanged on 6 December, while five members voted for a reduction. Somewhat unusually, the rate cutters were split, however, with three wanting a reduction of ½%, but one wanting a cut of ¼%, and another a more aggressive cut of ¾%. It could be argued therefore that the SMPC had voted for a ½% reduction with a five/four majority, on average, although this oversimplifies the more nuanced debate set out below.

All of the SMPC members concerned were aware of the uncertainties created by the global credit crunch and the associated danger that this could lead to a sudden cracking of the robust UK economic conditions reported for the third quarter of this year, when much of the official data expires.

Comment by Tim Congdon
(London School of Economics)
Vote: Cut by ½%
Bias: Wait and see

Long-run money/income relationships are difficult to interpret given the current short-run uncertainties. The November 2007 Financial Statistics came in the post this morning and I thought I would check how much the crisis had affected the size of the sterling inter-bank market. The answer is that UK banks’ sterling inter-bank assets fell from £639.7bn at the end of August to £248.6bn at the end of September. No doubt much of this was the cancellation of off-setting lines, but banks that have traditionally been net recipients of inter-bank funding are being squeezed savagely. There is so much to say, but the restoration of banking ‘normality’ is essential.

My verdict is that – at current interest rates – the stock of UK bank lending to non-banks, and hence the level of bank deposits and the M4 money measures, might even fall for a month or two at some point in the next six months. The Bank of England and the Financial Services Authority (FSA) plainly don’t know what has hit them. I am in favour of a ½% cut in base rates. (Incidentally, my forecasts that this cycle would end with rates of 6% or above has been correct, in terms of inter-bank rates, although I could never have dreamt the precise circumstances. For those who are interested, UK banks’ balances with the Bank of England jumped from £16.8bn at end-August to £24.1bn, which would imply a surge in M0 if it were still being calculated. To me that simply shows the irrelevance of M0, but no doubt there are other views.)

The main reservation here is that a ½% cut in base rates might trigger a 5% or so fall in sterling. That is why it would be better for the Bank of England to restore the normal working of the inter-bank market by supportive money market operations, but my verdict is that the relevant officials are reluctant for the Bank of England to appear particularly active in the money markets. Major improvements to the 1998 Bank of England Act are needed.

Comment by John Greenwood
(Invesco Asset Management)
Vote: Cut by ¼%
Bias: Cut more if economic conditions deteriorate further

The credit crunch of the past few months has dramatically changed the economic outlook. With house prices now clearly falling, CPI inflation close to target at 2.1% in October (and recently below target), retail sales declining by 0.1% in October, real GDP growth slowing to 0.7% quarter-on-quarter in 2007 Q3, and business investment flat in the same quarter (albeit up 4.6% on the year), the economy is much closer to a tipping point than in any period in the last few years. These data on activity and inflation are supplemented by weakening money and credit data. In October, sterling M4 broad money rose only 0.1% over the month, and slowed to 11.8% on the year, while total lending also slowed sharply.

Meantime, in November short-term money market rates have risen again to new peaks with three-month sterling London Inter-Bank Offer Rate (LIBOR) above 6.5% and 2-year credit swap spreads (the difference between inter-bank lending rates and equivalent maturity Treasuries – a measure of risk aversion) rising above 110 basis points compared with normal levels of 30 basis points. These signs of stress in the money and credit markets imply further weakness ahead both for economic activity and inflation. As yet there is room for doubt as to the certainty of economic weakening because symptoms of the preceding euphoria still persist – for example in some of the commodity markets. Nevertheless the Bank of England needs to move now to get ahead of the markets by lowering rates. I would cut rates by 25 basis points, with a bias to cut more if economic conditions deteriorate further.

Comment by Ruth Lea
(Arbuthnot Banking Group and Global Vision)
Vote: Hold
Bias: Towards cuts

Much was made in the media about the recent marginal downward revision to the GDP data for the third quarter. Instead of a 0.8% quarterly increase, as originally estimated, GDP growth was estimated to be “only” 0.7%. But this number was still strong and hardly suggested that the economy was suffering from any serious effects of the credit squeeze, which developed in August, during that period. The increase in domestic demand was over 1.0%.

The recent economic news has, however, been much less comforting. Most survey evidence, including that from the Bank of England’s regional agents, has been negative. The housing market is beginning to look very ugly. The British Bankers’ Asociation (BBA) mortgage approvals data for October slumped. But the progressive introduction of the excessively bureaucratic Home Information Packs (HIPs) has probably had a negative impact on the market, though at this stage it is impossible to judge just how significant the impact has been.

In addition, the equity markets have been extremely volatile and look expensive in the current economic climate. It can fairly safely be said that the bull market is over. The inter-bank market remains far from normal and, given the Bank of England’s apparent reluctance to “normalise” it, there will surely be further turns in the credit squeeze on households and businesses – especially on high risk households and on smaller and riskier businesses. These domestic developments, along with the undoubted slowdown in the US (the UK’s most important individual trading partner), clearly threaten Britain’s growth prospects. But the speed and the extent of these negative impacts on economic growth are unusually uncertain.

There are, however, not just growth risks. There are also inflation risks, which present the Bank of England with a dilemma. Producer prices inflation has recently picked up, not least of all reflecting the rapid increase in oil prices. CPI inflation has also risen. Under these circumstances, I vote, on balance, for no change in December – but with a strong bias towards easing.

Comment by Andrew Lilico
(Europe Economics)
Vote: Hold
Bias: Neutral

I believe that this is a moment for masterful inaction. I can understand the temptation to cut in the face of a building second hump in three-month interbank rates indicating a second phase to the credit squeeze, and other data indicating broad money growth slowing very rapidly. But the MPC's mandate is to meet its inflation target - all other matters are secondary. Perhaps they should not be, but that is a policy matter for another time. And inflation is currently above target, is projected to go further above target over the next few months and to stay there for a whole year, and presents a risk of going above the 3% threshold early next year. It would be potentially disastrous to combine a significant squeeze with further lost credibility from going above 3% and to face a scenario of raising rates materially at the same time as broad money growth collapsed, house prices fell, and GDP slowed.

Further, although the credit squeeze is clearly having an effect on financial markets, and may well feed through into lending for investment as well as private consumption, it is still far from clear what negative real impact this reduced willingness to lend will have. It has been thought for some time that consumers had over-borrowed, and some degree of retrenchment may well be economically positive. That is not to say that one should let matters run out of hand - I'm not proposing an Andrew Mellon strategy. But I think that a panicky response is as likely to damage confidence as to underpin it. For now, as far as we know, all there is is retrenchment and a temporary stalling in credit, and at the same time we must have a concern about above-target inflation for the near- to medium-term. Unless matters go spectacularly badly - say, large stock market falls, or a large fall in oil prices - I would urge that rates be held at least until February, when we can think again with clearer heads and more data.

Comment by Patrick Minford
(Cardiff Business School, Cardiff University)
Vote: Cut by ¾%
Bias: Cut by a further ¾% in early 2008

It is difficult to understand why the Bank is proving so slow to respond to a situation that has been eminently predictable since September at least. It is obvious that the interest rate the Bank should be trying to fix under their 'interest-rate policy' is the market rate for the private sector, roughly speaking the inter-bank rate. (It can hardly wish to target the government borrowing rate!) Well, this rate has gone up since August from 5.75% to around 6.5%, equivalent to a 75 basis point rise in Bank Rate. Yet the Bank which never intended this to happen in August has sat idly by.

It is true that third quarter growth was strong; but that reflected history before the banking crisis and this accompanying rise in rates. The rumblings and gnashing of the credit crunch have been loudly audible since then. For Mervyn King to tell us suddenly, in the week of the Inflation Report, that growth looks 'threatened', with strong consequent downward pressure on inflation makes the Bank look like fools. It had been obvious weeks ago.

I regard the Bank's behaviour as highly irresponsible, just as I regard its behaviour during August and September as both irresponsible and neglectful of a century of monetary teaching from Bagehot on. It is time for some sense to prevail. Rates need to be cut by 75 basis points at once to stabilise a fast-deteriorating situation. This, by the way, would just get us to where the Fed has already moved, in offset to the unintended rise in market rates. From then on rates will need to be cut further; I would like to see market rates at 5% quite soon in 2008. That implies, with the interbank risk premium at present levels, another 75 basis point of cuts early next year.

Comment by Peter Spencer
(University of York)
Vote: Cut by ½%
Bias: To cut

The credit crisis - which seemed to be resolving itself a month ago - is intensifying. UK inter-bank market rates have moved back up to a premium of 75 basis over base rate in the three-month area. This premium acts as a lightning rod, revealing the stress the banking system is under and transmitting this to other sectors. It reflects both counterparty risk and the pressure on bank regulatory capital posed by loan losses and the need to take Structured Investment Vehicles (SIVs) and other off-balance sheet vehicles back on board.

The bank reporting season could help to solve the problem of counterparty risk in the banking system, but will do little to resolve the problem in the hedge fund and SIV sectors, which remain completely opaque. It will do nothing to ease the pressure on regulatory capital. This pressure might be eased by by halting share buy-back programmes and floating subordinated debt. However, it will probably take large rights issues to solve this problem quickly – and it is hard to envisage banks engaging in these in the current environment. Short term, it seems they have little alternative to slowing the growth of the balance sheet by cutting back on inter-bank and other lending. The authorities may have to relax the regulatory regime just as they did for life insurance companies in early 2002.

As long as these pressures remain, banks will restrict the flow of credit to other sectors and make it more expensive. It is hard to estimate the effect this will have on the economy, since it is hard to find any recent precedent. The closest is perhaps the Savings and Loan (S&L) crisis that hit the US banking system in the early 1990s – when it took two years of low interest rates to recapitalise the banks. However, many companies borrow at LIBOR and other rates that move automatically with inter-bank rates, so their interest charges have already gone up. Average corporate borrowing rates are already 2 percentage points up on the year. The last time we saw this kind of increase (in late 2004) business investment growth fell back from 9% to below zero within six months.

My main concern is for small and medium-sized enterprises (SMEs) that tend to rely on their banks for medium-term finance. They are probably safe at the moment, but what happens when this is due for refinancing in say six months time? Many of these are in household goods and other sectors that have done well on the back of the cheap and plentiful flow of credit, areas that will surely be sensitive to a consumer slowdown. My worry is that the bank will take one quick look at this and simply say sorry.

The UK economy went into the crisis with a strong momentum, but is now decelerating sharply. Business confidence surveys fell back right across the board in October. Advance indicators of the housing market – notably mortgage approvals and the Royal Institution of Chartered Surveyors survey balances – also point to a sharp slowdown. If effective interest rates remain at these artificially high levels for much longer it is hard to say what will happen. I would cut base rates by ½% immediately to offset the inter-bank premium and bring three month LIBOR back towards 6%. I would then monitor lending conditions very carefully with a view to further reductions.

Comment by David B Smith
(University of Derby and Beacon Economic Forecasting)
Vote: Hold
Bias: Wait and see but tightening remains a possibility for 2008

It is possible to almost pity the MPC at present – if institutions can be pitied - because there is an extremely high probability that any decision they make will be the wrong one. In addition, the potential costs of errors of judgement have risen sharply, with the possibility of a credit implosion and serious recession on the one side being counterbalanced by the dangers of a run on sterling and an upwards ‘gear shift’ in inflation expectations on the other. The big picture is that Britain’s small open economy is heavily dependent on the wider global background. Many people have excessive faith in the ability of the MPC to control events and grossly overestimate the power of modest tweaks in the official REPO rate to influence the real economy.

The lax fiscal background revealed by the October 2007 Public Sector Finances data exacerbates the pressures on the monetary authorities, because of the resulting policy inconsistency. The widespread perception, following the Northern Rock and the missing Revenue and Customs computer disks affairs, that the late Mr Oliver Hardy is now in No. 10 Downing Street, and the late Mr Stanley Laurel in No. 11, also does nothing for the credibility of the wider policy framework or the attractions of sterling for global investors.

With the benefit of hindsight, it is apparent that the ‘Great Moderation’ of recent years was underpinned by a sensible and steady pace of broad money creation at the level of the mature industrial economies as a whole. However, the excessively low real interest rates from 2001 onwards led to an upwards creep in OECD broad monetary growth, an over stimulation of financial markets, and accelerating inflationary pressures in the prices of commodities and fixed assets such as property.

Recent pressures in the international financial markets can be regarded as the inevitable re-entry costs that had to be paid if monetary growth was to be brought to heel and international inflation to be kept tethered at around 2.0% to 2½% or so. Between 1996 and 2005 annual average broad money growth in the ‘core’ OECD area as a whole fluctuated in a remarkably narrow 4¾% to 5½% band, while CPI inflation only varied between just over 1½% and 2½%, despite an oil price which gyrated between US$13.4 for a barrel of Brent Crude in 1998 to a probable average of over US$73 this year (it was US$92.5 on 27 November).

However, OECD broad money growth picked up to average 6¼% in 2006 and a part-projected 7¾% this year (it was 8.1% in the third quarter alone). Such numbers are not consistent with the maintenance of slow and steady inflation in the long run. However, the high level of credibility achieved by Central Banks by the mid 2000’s meant that the longer-term inflation implications of this monetary acceleration have not been anticipated by economic agents, at least so far. This is why accelerating OECD monetary growth had stimulatory effects on economic activity and the price of fixed assets in recent years that, in turn, led to further speculative activity and credit demand.

The hard-line implication that follows from this analysis is that people who go on a credit binge will ultimately suffer a hangover, and that ‘hair of the dog’ treatment by central banks exacerbates this addiction in the long-run, and may ultimately destroy the credibility of their counter-inflationary commitment. However, this does not mean that broad money and credit growth should be allowed to collapse, which is the mistake made by the Bank of Japan’s ‘sado-monetarists in the early 1990’s.

An outbreak of credit rationing can also lead to sudden and powerful adverse effects on economic activity that are simply not incorporated in conventional forecasting models, particularly those employed by most central banks (indeed, one suspects that the downwards adjustments to the Bank of England’s Inflation Report growth forecasts between May and November were largely the result of applying negative residual adjustments to the forecasts generated by the Bank’s model – it would be nice to know). This is an important point where the UK is specifically concerned because the economy appears to have been glowing red hot in the third quarter, when most of the official data expires, with non-oil market sector Gross Value Added (GVA) rising by 0.9% quarter-on-quarter (or 3.9% annualised), to stand 4% higher than in 2006 Q3, and the deficit on net exports of goods and services equalling some 4¼% of the basic-price measure of GDP. The recent easing of the sterling index to 100.9 (January 2005=100) might also be considered as a warning shot across the bows where future inflation prospects are concerned.

There is a widespread assumption in the current interest-rate debate that the present level of three-month interest rates is somehow ‘wrong’ and that the generally noticeably lower official REPO rates are more appropriate to the underlying economic situation. This view may not be entirely correct, however. In particular, if one assumes that the normal three-month real rate of interest in the world as a whole is around 2%, when the OECD output gap is at neutral, and adds on the latest ‘headline’ CPI figures, then this suggests that: the three month rate in the US should be around 5.5%, compared with its present 5.0%; the Euro-zone three month rate should be 4.6%, which is broadly where it is; and Japan’s three month rate should be 1.8%, compared with the observed 1.0%, although this is a somewhat artificial calculation because of Japan’s mildly negative annual inflation rate.

A similar calculation for the UK using my preferred ‘double-core’ retail price measure, which rose 2.8% in the year to October, would suggest an equilibrium three-month rate of 4.8%. However, a freely estimated statistical relationship using data for the past four decades suggests that one might also want to add on the ratio of the balance of payments deficit to GDP, which is presently around 3½%. This suggests that Bank Rate could rise to 8¼% in a worst case scenario, in which overseas investors refused to plug the payments gap with the cheap capital inflows that have been engendered by the attempts of leading economies in Asia and elsewhere to hold down their exchange rates. This 8¼% is most definitely not intended as a forecast in any shape or form. However, it is noteworthy that in the mid 1990’s, when core inflation was around its present level for several years, but the payment’s deficit was much smaller, Britain’s official REPO rate fluctuated around 6% to 6¾%, which is reasonably close to where three month inter-bank rate is today (6.5% on 27 November).

Overall, while recognising that there are serious downside risks to the credit creation process and economic activity, I do not believe that the evidence as yet supports the case for a cut in Bank Rate, and suspect that more damage will be done if inflationary expectations take off, or there is a run on the pound, than will be averted by aggressive rate reductions in the immediate future. Beyond that the only viable policy seems to be ‘wait and see’, while noting that rate reductions overseas stimulate the British economy through the trade account and are to some extent a substitute for rate cuts at home.

Comment by Peter J Warburton
(Director, Economic Perspectives Ltd)
Vote: Cut by ½%
Bias: To cut

During the past month or so, global credit conditions have tightened demonstrably. US credit impairments that were obvious months ago were formalised by a flood of rating downgrades in mid-October. These have forced commercial and investment banks and other non-bank financial institutions around the world to acknowledge further asset write-downs and realised losses. A downward spiral in US house prices, feeding on the escalation in foreclosures, continues to undermine asset quality. Financial losses emanating from the US mortgage market and structured finance are now expected to reach US$500bn with multiplier effects on other segments of the credit system. In short, a profoundly deflationary credit downturn has taken hold.

The implications for the UK economy of this global credit event are becoming apparent, week by week. A small subset of private sector services, including computer services, other business services (legal, accounting, recruitment etc.) and financial intermediating is contributing over 60% of quarterly GDP growth in 2007 Q3. This subset of activities is particularly vulnerable to a setback in global capital market activity and a loss of momentum in credit growth. Declining activity rates in UK residential and commercial property markets add another dimension of concern. Consequently, the UK must be considered one of the most exposed economies to the global credit downturn.

Over the past week, credit traumas have spilled over into the interbank markets in a reprise of the August debacle. Hence, the premiums of interbank rates to base rates in the major currencies have widened again, penalising borrowers in the wholesale financial markets and the swaps market. In the case of LIBOR, it would require an immediate cut in base rate of about 50 basis points to offset this inadvertent tightening. The dramatic events of recent weeks have injected urgency into the situation and my preference is for Base Rate to be cut straightaway by the full 50 basis points. Further interest rate reductions are expected to be required over the coming months. However, the cost of borrowing to businesses and households is unlikely to fall until base rate reductions become material. A sharp deceleration of UK economic activity is expected in 2008, regardless of the likely profile of base rate cuts.

On the specifics of the UK’s inflation target, the October retail price release contained more good news regarding private sector goods and services inflation and more bad news on the collection of administered and exogenous prices such as oil prices and indirect taxes. With annual private sector inflation back to around 1.5%, base rate has scope to fall to around 4.5% during 2008.

Comment by Trevor Williams
(Lloyds TSB Corporate Markets)
Vote: Hold
Bias: Strongly to ease

Growth in the UK economy is slowing, with the Purchasing Managers’ Indices (PMI’s) for services and manufacturing suggesting a decelerating pace. The service PMI was 53.1 in October from 56.7 in August; the manufacturing PMI was 52.9 from 55.1 and that of construction was 57.4 from 60.3. However, the deceleration as yet is neither dramatic nor deep and still supports expansion of around 3% a year. Retail sales growth fell in October, though by only 0.1% and was still 4.4% higher than in the year before. But manufacturing output fell by 0.6% in September and was a little lower than a year earlier, suggesting that a slowdown is underway. This means that there is time for careful judgement about the reaction of monetary policy to the slowing pace of activity.

There are also signs that inflation is still an issue. Unemployment on the claimant count fell by nearly 10,000 in October, as annual wage inflation including bonuses rose for a third month in succession, to 4.1%, the first time since March that it has been above 4%. Moreover, food prices are high, oil prices are rising and so it was no surprise that consumer price inflation rose to an above target 2.1% in the year to October, the first rise since March. Retail price went back above 4%, to 4.2% and RPIX which excludes mortgages went back above 3%. It is no wonder that inflation expectations have not fallen back much, though this is likely to change in the months ahead.

News that UK GDP was revised down to 0.7% from 0.8% in the third quarter looks positive for rate cuts on the surface. But what would likely lead the MPC to conclude that growth was still healthy would be the figures for market sector GVA, which is private sector driven. This showed that the economy grew by 0.9% in 2007 Q3 and was 4% higher than in the same period of 2006. This compares with long term averages of 0.8% and 3.4%, respectively.

But the fact is that the credit crisis does seem to be inducing a deceleration in the growth of the M4 money supply and keeping interbank rates at levels consistent with a base rate of 6.25%. These trends imply that official rates should fall. Moreover, there ought to be some action taken to try and get LIBOR closer to where the base rate implies, by injecting liquidity into the interbank market. With the development of credit markets has come new risks and so new monetary tools and approach are required from central banks to tackle what remains a brutal liquidity squeeze for those have to access interbank markets. The ECB has pointed the way, with repo market activity and acceptance of a wider range of collateral for open market operations. In order to more cleanly focus on inflation and growth, the Bank of England may have to be more creative. I would leave rates on hold in December, but with a clear bias to ease once there is more evidence on growth and inflation trends.

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 Kent Matthews of Cardiff Business School, Cardiff University, and its Chairman is David B Smith (University of Derby and Beacon Economic Forecasting). Other current members of the Committee include: Patrick Minford (Cardiff Business School, Cardiff University), Tim Congdon (Visiting Fellow, London School of Economics), Gordon Pepper (Lombard Street Research and Cass Business School), Anne Sibert (Birkbeck College), Peter Warburton (Economic Perspectives Ltd), Roger Bootle (Deloitte and Capital Economics Ltd), John Greenwood (Invesco Asset Management), Peter Spencer (University of York), Andrew Lilico (Europe Economics) Ruth Lea (Arbuthnot Banking Group and Global Vision) and Trevor Williams (Lloyds TSB Corporate Markets). 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.

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