Bank of England Keeps 5.0% Key Rate as Expected

September 4, 2008

For a fifth straight meeting, the Monetary Policy Committee of the Bank of England decided not to change its Bank Rate.  Britain has entered a recession, but inflation is more than twice as high as the inflation target of 2.0%.  The CPI’s 12-month rate of advance climbed from 2.5% as recently as March to 4.4% in July.  The monthly policy meetings in July and August each ended with votes of 7 for no change and 1 dissent each for hiking by 25 basis points (cast by Besley) and cutting by 25 basis points (Blanchflower).  Minutes of this week’s meeting will be published on September 17th.

The housing market in Britain is in shambles.  The Halifax house price index was reported today to have fallen 1.8% in August and by 12.7% from August 2007.  That’s an adverse swing from -8.8% in the year to July, -3.8% in the year to May, and +11.4% in the year to August 2007.  Mortgage approvals of 33 thousand in July were 42% below their level in April and the lowest since at least 1993 when this data series began.

The one good piece of news on the inflation front is that labor costs are subdued and getting more so.  On the other hand, sterling depreciation poses a rising risk of import price inflation.  The Bank of England’s key rate has been lowered just once by 25 basis points since mid-February, but the trade-weighted pound’s 8.6% decline since then will act like an additional 215-basis point cut in rates.  Taking an even longer perspective, the Bank Rate also stood just 25 basis points higher than now on January 23, 2007, but the trade-weighted exchange rate since that date shows a loss of 17.1%, which empirical studies suggest should pack about the same punch as a 4-1/4 percentage point reduction of interest rates.  Mindful of that development, the majority of Bank of England policymakers continues to show patience in waiting for confirmation that inflation is receding before resuming a cycle of interest rate cuts.  So far, there have been just three moves, each by 25 basis points last December, February, and April.  The current 5.0% level is the highest among G7 members.



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