Will Interest Rates be cut next week? (G021b)
The answer: quite possibly and almost definitely by January 2009.
We can forget at this stage Fiscal and Monetary policy textbook definitions/solutions for the UK economy ; political and economic reality on the ground suggests that the UK has been in recession for many months and its getting worse. One only has to look at the Building Industry (collapse), the Pub/Brewery Business (closing scores of pubs every week), the Finance Sector laying off thousands of jobs in the City and the Provinces, the Retail Sector (Marks and Spencer and John Lewis announcing major decline in sales), Car Sales (prestige and medium value cars down in excess of 50%), Hotel and Leisure (on its back) etc etc.
The Bank of England Monetary Policy Committee (MPC) which meets on Thursday 9th October is faced with a very simple but stark choice. Reduce interest rates and attempt to prevent a worsening of the recession already gripping Britain or keep them on hold to at least give the impression of holding out against inflation (a rise is simply just inconceivable) or until it is certain that inflation has peaked (the Consumer Price Index showed a rise to 4.7% in August against the Bank of England target of just 2%).
The Purchasing Manager’s index for the UK services sector fell in September to 46 from 49.2 in August – heralding a sharp decline in new business as a result of dwindling confidence as the global financial crisis gathers pace. With unemployment rising and the hotels and restaurant sectors being particularly hit, there is little to suggest that a recovery is all but a far way off.
With inflation however being somewhat curtailed as the result of lower oil prices, and in view of the comments made in the first paragraph of this article, it seems very likely, that the MPC can justify an interest rate cut of 0.25% - 0.5% in the short term.
However, working against this, are the effects of higher utility, food and supplier prices, and the pound under pressure against the dollar (dropping 3.8% last week to $1.7750).
One of the strongest factors holding back interest rate cuts at this time is the attitude of Mervyn King (Governor of the Bank of England) himself and supported by the majority of his Committee. In his letter to the Chancellor last month, he wrote:
"the Committee has become firmer in its belief that a period of muted economic growth is necessary to dampen pressures on prices and wages and return inflation to the target".
Pitted against this is: the announcement that UK House prices recorded their largest one year fall since 1991; the rise in LIBOR rates (the rate at which banks lend to each other – if they do at all); and the Halifax raising interest rates to mortgage customers - it will be difficult for all but an ‘Iron Governor’ not to reduce rates on Thursday, if only to help hold off further declines in confidence.
From an Associates Blog.
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