Bank of England Likely to Cut Bank Rate More Than 50 Bps Tomorrow

November 5, 2008

From a peak of 5.75% from July 2007 until December 2007, the Bank of England’s benchmark interest rate was lowered in four increments to 4.5%, consisting of 25-basis point cuts last December, February and April and a 50-bp reduction on October 8th in conjunction with a Fed-led consortium of other central banks. The first three reductions were made against the backdrop of conflicting concerns of weakening growth but accelerating inflation. Minutes from last month’s cut to 4.50% show that reservations to easing had all but vanished by last month. In a unanimous vote, officials said the “balance of risks to inflation in the medium term had shifted decisively to the downside.” The minutes spoke about markedly worse credit and money markets, a risk of a sharper monetary contraction, and the likelihood of rising spare capacity that will cut inflation.

Since the October meeting, the Bank of England’s chief economist and deputy governor, Charles Bean, said this is the largest financial crisis of its kind in history, and new EU Commission forecasts look for a bigger hit to the U.K. economy than elsewhere in Europe. Real GDP in 3Q08 fell 2.2% at a seasonally adjusted annual rate, with negative growth contributions from production, construction, and services. Growth from 3Q07 of just 0.3% was the lowest on-year rate since 2Q02. Factory output in September, reported earlier today, fell twice as much as assumed (-0.8%), raising the possibility that third-quarter growth will get revised to a sharper drop. The CBI industrial trends survey weakened to -39 in October from -26 in September, pointing to worsening momentum in the fourth quarter. Measures of consumer confidence have been mixed. However, consumer credit is near to a 15-month low, and the volume growth of retail sales of 1.8% in the year to September was the lowest since February 2006. The October PMI readings were devastatingly weak: 42.4 for services and 41.5 for manufacturing. Those scores are down from 49.2 and 45.3 in August and represent drops of 8.4 points and 8.9 points in the six months since April. The Nationwide house price index fell 14.6% in the year to October, most since at least 1974. The construction PMI in October of 35.1 was down from 38.8 in September and the lowest since at least 1997. Jobs are falling now about 40K per month, and unemployment has been rising at a monthly clip above 30K. Exports will be hit by the global downturn, and sterling still looks overvalued despite recent depreciation.

CPI inflation climbed to 5.2% in September. That undoubtedly is the peak, and it could now fall pretty quickly. Average earnings increased 3.4% on-year in the latest 3-month period, least since mid-2003. At 4.5%, Bank of England easing is behind where it ought to be at this stage. If inter-meeting reductions are to be avoided in the future, now is the time to slice the rate by more than 50 basis points, most likely by 75 bps but possibly matching Australia’s recent 100-bp move.



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