Bank of England Minutes Edged Closer to Cutting Rates

September 17, 2008

After meeting September 3-4th, Bank of England policymakers left the Bank Rate at 5.0%, the same decision that was made in the four previous monthly meetings, but minutes released from that meeting document some movement closer a resumption of the easing done last December, February, and April.  The minutes are full of on-the-one-hand, on-the-other-hand thinking, and there again was discussion of the merits of raising rates as well as lowering them.  The closest phrase to a hint that a cut might be made by November comes near the end of the document: “It was more than usually important to stress that the Committee would continue to make its judgement each month on the basis of the changing evidence.” 

Global and domestic news since September 4th suggest a further migration toward easing.  U.S. investment banks are dropping like flies, and interbank lending has become even stingier.  British producer output prices fell 0.6% m/m in April instead of holding flat as forecast.  Producer input prices slumped 2.0% from July.  U.K. industrial output fell 0.4% in July and 1.9% from July 2007, which were worse results than anticipated.  Same-store retail sales dropped 1.0% in August from a year earlier, their third consecutive on-year decline.  The prestigious NIESR estimated a 0.2% decline of real GDP over the three months to August, which was a bigger drop than in the three months to July.  Wages, up 3.5% in the year to May-July, are advancing more slowly than consumer prices.  Unemployment shot up 32.5K in August, the biggest jump in 188 months, and the CBI monthly survey of industry handed down three valuable pieces of information in support of giving a rate cut a chance: 1) the orders index fell to -26 in September, lowest in 32 months, from +1 in June, 2) an expected output reading sank to -16, worst since December 2001, and 3) there was a surprising 8-point slide in expected inflation.

The minutes talk about more financially stressed conditions, increased downside risk to final domestic demand growth, the lack of evidence that medium-term inflation expectations might become dislodged, slower growth in nominal GDP, money and credit, unanticipated inventory build-ups, deteriorating housing market conditions, and slower-than-expected real growth in the euro area.  And then there is the voting pattern of Committee members.  Blanchflower, who has dissented from the no-change majority in favor of easing at each of the last five meetings, upped the size of his recommended reduction to 50 basis points, while Besley withdrew the dissent in favor of a 25-bp rate hike that he had cast in both July and August.

The biggest two reservations against immediately cutting rates are the much higher-than-targeted 4.7% rate of CPI inflation, which could lift expected inflation and generate second-round price hikes, and sterling depreciation, which by lifting import costs might delay the onset of a downtrend in CPI inflation.  These dangers are getting smaller.  It’s hard for a wage-price spiral to dig deep roots without upward pressure on wages, and sterling’s impact ought to be neutralized by sharply falling commodity markets.  When it comes to inflation, the times are a-changing and doing so fast.  I was talking to a contact about U.S. inflation yesterday, a person who earlier this year was trying to convince me that true CPI inflation must be in double digits for anybody who does a lot of retail shopping especially of food and energy.  This same person now fears deflation.  What’s true here could be equally appropriate about Britain.  Actual consumer prices surely will not shift from one extreme to the other as my contact perceives, but expected inflation is likely to magnify the change in direction.  For central bankers fearing that expected inflation might become “dislodged,” the news is apt to get better in coming months.  Conventional wisdom still leans solidly against a British rate cut in October, and many analysts are holding out for no move until 1Q09, when the CPI data will be safely in retreat.  Don’t be surprised if such thinking starts to creep inward toward a shorter interval.

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