Bank of England Meeting Preview

May 7, 2008

At 11:00 GMT on Thursday, I expect the Monetary Policy Committee to announce that it is not changing its 5.0% bank rate. A cut of 25 basis points was made a month ago as well as ones of similar size in December and February. Unlike the norm at most central banks, the Bank of England does not set interest rates by consensus. Each of the nine policy committee members is encouraged to think independently. They vote, and the majority rules. Only at the Bank of England does one get results as in April wherein there are members dissenting on either side of the majority decision. With such a streak of independence, it is very hard for officials to steer the market toward correct expecations. Surprise votes are more common than elsewhere.

That being said, my forecast is what most analysts anticipate. The choice will be between cutting by 25 basis points or not changing rates. Every policymaker in April expected the next rate move to be downward, but no consensus existed in April on the timing. Mr. Besley and Mr. Sentance thought the 25-bp cut in April was too soon given continuing elevated expected inflation. They would prefer to offset downside growth risks only if price risks also lay to the downside, which such do not. Sterling losses and ever-higher energy prices are big price risks. A scheme to inject liquidity (about $100 bln worth) by swapping mortgage-backed securities for government paper can best address the financial markets’ breakdown, while monetary policy should stick to its mission of preserving price stability. Mr. Blanchflower, on the other hand, wanted a 50-bp rate cut in April and will no doubt dissent again in favor of a cut in May. He finds parallels with the U.S. sitation and has predicted a 30% drop in U.K. housing prices if rates are not reduced aggressively. Governor King, who sided with the majority, nonetheless has often expressed his concern about stubbornly elevated expected inflation. He would be uncomfortable with the message of cutting rates in consecutive months and for a third time in four months, even though as Blanchflower repeatedly points out wage costs remain contained.

The data since the MPC met in April have been too worrisome for the committee not to entertain the notion of cutting rates again this month. On-year house price inflation was negative according to the Hometrack, Nationwide, and Halifax indices. Consumer confidence has not been weaker since November 1992. The CBI’s two surveys tumbled in April by 27 points in the case of retailers and by 18 points for industry. Mortgage approvals and loans were at multi-year lows. The factory PMI of 51.0 and services PMI of 50.4 depict an economy that has stalled, and weaker-than-assumed industrial output in 1Q (-0.2% from 4Q) suggests that real GDP will be revised downward from the initial indication of +0.4%. From when the first of the three rate cuts was implemented in December to the third move last month, the trade-weighted pound had depreciated about 7.5%, which is likely to have exerted an equivalent stimulus as would a rate cut of around 190 bps. Since the April meeting, however, the pound has climbed 1%, neutralizing the boost from the third rate cut. That better tone could be thrown away if the Bank of England springs an unexpected rate cut on the markets tomorrow. Viewed from a different angle, the weakness of sterling in 2008 is what justifies a higher nominal central bank rate in Britain than in Euroland despite lower on-year CPI inflation in the U.K. than in the euro area.



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