Bank of England Preview: Markets Look for No Rate Change Yet

September 3, 2008

The Bank of England’s key rate has been at 5.0% for the past five months after three reductions of 25 basis points each last December, February, and April.  The surprising thing about this week’s meeting is how solidly investors are convinced that rates will be lowered again in 2008, but just not this month.  From a central banker’s standpoint, if no reasonable doubt remains about the need for a rate cut within four months’ time, it ought to take extenuating arguments to dissuade one from not implementing the move right away.  The lack of overwhelming expectations for a bank rate cut in September is a sign that the Monetary Policy Committee retains a fair degree of credibility that undue risks with inflation will be avoided at all costs.

British economic conditions and prognosis have not been as poor as now since the very early 1990’s.  The U.K., where GDP firmed merely 0.2% saar in 2Q08, is the only G7 member whose economy is projected by the OECD to contract in both 3Q08 and 4Q08, and the outlook remains bad for early 2009.  Both PMI’s have been lower than the 50 line between expansion and contraction for each of the past four reported months.  All aspects of the housing market are free-falling.

The last two policy meetings ended in 7-1-1 split votes.  More than one dissent in favor of a rate cut had been anticipated at the August meeting, but nobody sided with the perennial dove, Blanchflower.  CPI inflation 4.4% is not only above target, but more than twice the 2.0% medium-term goal, and core and expected inflation have crept higher, too.  No central bank has delivered more surprise verdicts since 2000 than the Bank of England, and that is not an accident.  Whereas the ECB and many other monetary policy institutions have a culture of consensus politics, policymakers at the Bank of England are encouraged to think for themselves and decide by majority vote.  That style worked incredibly well for the first ten years, when on-year inflation hovered near target and deviated from such by more than a percentage point just one.  The British economy has gone awry in the last year.  A lack of fiscal consolidation when the economy was running well is now hamstringing the scope for meaningful fiscal support.  Being more dependent on financial services for growth than most economies and insofar as the U.K. housing market was even more overbought in early 2007 than its U.S. counterpart, the U.K. was feared to be especially vulnerable when the sub-prime crisis first broke just over a year ago.  The only source of stimulus in an otherwise bleak landscape has come from the depreciation of sterling, but that boost is being watered down by diminishing demand in Britain’s export markets.

The Bank of England announcement on Thursday will be made at 11:00 GMT.  Minutes will not be released until September 17th.  If officials surprise markets and cut rates, a statement will be released immediately.  On very rare occasions, officials have the option to release a statement even if policy is not modified.  I do not expect that being done tomorrow.



One Response to “Bank of England Preview: Markets Look for No Rate Change Yet”

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