Comments: Bank should cut, but not panic

Maybe they could justify it with the truth - that falling credit demand means they would need to remove lots of liquidity from the banking system to keep rates at a high target, and they cannot do this as it would cause too much stress in certain banking institutions? That, after all, is precisely the reason the Fed was forced into the emergency 75bps cut a few days ago.

Posted by Minh at January 27, 2008 02:09 AM

David, I broadly agree with what you're saying. I just want to make a few points.

Concerning the issue of global forces affecting the UK inflation rate. I fully agree that policy should be set to meet the 2% target over the 2-year horizon. But on this occasion, there are two other factors to consider. First, cutting interest rates while inflation is heading towards the 3% target could give the impression that the MPC targets growth, not inflation. This could be dangerous when there is already uncertainty about the level of inflation expectations.

Second, the exchange rate. The pound has already fallen sharply and the rebalancing process that Merv spoke of is likely to involve further falls. This will intensify the impact of global price pressures. For example, the UK isn't likely to benefit entirely from the recent drop in the oil price. So to some extent, the trade-off between growth and inflation could deteriorate for a period.

This is all about how the Bank responds to demand and supply shocks. There has been an obvious demand shock (the credit problems), but also supply shocks (the fall in the pound, the rise in energy prices and other globally-traded goods). The Bank needs to ensure it responds consistently to these. In 2003, the Bank cut interest rates because it was concerned about disinflation/deflation (the positive supply shock coming from Asia). These concerns outweighed the strength of consumer spending and the housing market (a demand shock).

I’m not suggesting the MPC shouldn’t cut interest rates. As you point out, rates are still in ‘restrictive’ territory. But policy might have to remain slightly tighter than would otherwise have been the case. The Bank should also be cautious about how quickly it cuts.

Posted by Sell Everything at January 27, 2008 10:47 AM

I get a bit fed up with people "reading between the lines" and then drawing a bunch facts from it that purport to be fact. And I quote from your column
"5.5% Bank rate is already “probably bearing down on demand”. So there will be rate cuts,"
Well if you raise interest rates then its purpose is to bear down on demand, maybe Merv was merely commenting that that the medicine was having the desired effect ! although the first word is probably.........
So you have drawn a conclusion that interest rates must rise on the basis of a comment the can be interpreted in many various ways and which the originator only posed as a question.
Really very sloppy thinking !!!

Posted by Bryan C at January 27, 2008 09:48 PM

And I'm getting a bit fed up of your tedious and sloppy comments. I think you mean "fall" when you write "rise", and you clearly don't know the way these things work. A central banker never says: "I'm going to cut interest rates next month". Our job is to try and interpret what they say - which is always somewhat oblique - and, indeed, to read between the lines.

Posted by David Smith at January 28, 2008 08:54 AM

Dear David,

Correct I did mean fall and not rise. And strangely enough I do know how these things work indeed central bankers are deliberately Delphic and one of the reasons they are is because they don’t set interest rates, they only have one vote (and an unknown degree of influence on the other member of the committee) in our the MPC set up one vote of nine.
And I am sorry if my comment came across as rude it wasn’t meant to be, but I stand by it. One rather ambiguous comment by a central banker, who is one ninth of the franchise, and who wasn’t certain of the comment himself hence the word “probably” is not compelling evidence of falling interest rates. And it is important because you base the rest of your column on that fact
Bryan C

Posted by Bryan C at January 28, 2008 12:46 PM

David,

I have been searching and am yet to find a succinct definition for 'hair shirter' the best guess from what I've found is some reference to hair shirts worn by medieval monks, that were purposely uncomfortable in some strange form of self flagellation. I am wondering what the link is between this behaviour and attitudes to interest rates?


Posted by OldFashionedBanker at January 28, 2008 02:20 PM

Still tedious Bryan C, not least because the column was not based purely on a reading of Mervyn King's speech. As for Old Fashioned Banker, I'm sure you know what I mean by hair-shirters.

Posted by David Smith at January 28, 2008 03:24 PM
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