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 05 July 2008 14:15 BST

Interest rate monitor

Monday, 01 Oct 2007 00:00
The MPC meets on Thursday to vote on interest rates
On Thursday the Bank of England's monetary policy committee (MPC) announces the outcome of its monthly meeting deciding whether to lower, hold or raise interest rates.

InTheNews assesses the current economic situation to work out what might be running through the heads of its seven members in the run-up to October's meeting.

September's decision

Last month the MPC unanimously approved a second consecutive hold of interest rates at 5.75 per cent. The harmony was largely the result of consumer price index (CPI) inflation falling below the government's target rate of two per cent to 1.8 per cent, a figure driving down expectations of a further hike by the end of the year.

Following the meeting, whose minutes revealed the committee believed upside inflationary risks had "receded", analysts were considering the likelihood that the Bank would keep rates fixed for the rest of the year. Such speculation was blown out of the water by events in September, however.

Pundit predictions

On September 13th it emerged that Northern Rock had been granted emergency funding by the Bank of England because of liquidity difficulties caused by the global credit crunch. The announcement had been intended to reassure depositors but instead prompted a disastrous run on the bank only halted by the Treasury underwriting all deposits.

The crisis may have been stopped by the move, but the shocking developments provoked another round of concern about credit availability. The Federal Reserve reassured wavering markets with a half-point cut. Now it is the MPC's turn to decide how to deal with the aftermath.

"The impact of financial market disruption would depend on how long it persisted and how widespread it turned out to be," minutes from the September meeting noted. Pundits puzzling over whether this and other statements indicate a pressure-easing cut is on the cards are not clear what the MPC will decide on Thursday. A look at the three main areas of the economy reveals that long-term trends remain important, but volatility inevitably creates uncertainty over how much these will develop in line with expectations.

Retail

First indications of September's performance appear to be showing an improvement on August's figures. According to the Office for National Statistics (ONS), three-monthly growth up to August increased its pace by 0.1 per cent to 1.3 per cent. The Confederation of British Industry (CBI) saw spending increase in September.

So it seems credit worries on the markets may not be translating into diminished spending on the high street. Instead retailers continue to warn that the five quarter-point hikes seen in the 12 months to July are having an impact.

John Longworth of the CBI's distributive trades panel said uncertainty caused by Northern Rock posed a risk, however.

"The Bank needs to keep a watchful eye on future confidence, which risks being dented further as a result of increased uncertainty about the economic outlook into 2008," he said.

Property

Faith in the housing market's slowdown over the spring and summer has taken a bit of a beating with recent property figures suggesting activity is picking up yet again. The Land Registry's figures released on Friday show relative stagnation – 0.2 per cent is not exactly roller-coaster pace growth – but it is an advance nevertheless.

Figures for September suggest a broad continuation of unmoving prices, which are either teetering or stable according to preference. The Bank is likely to view property as an upside risk for now but the market, whose mortgage activity is closely linked to the Northern Rock scare, will certainly be more cautious in future.

Hometrack director of research Richard Donnell said: "Turmoil in the financial markets has created a period of inertia in the housing market with buyers and sellers unwilling to commit until the outlook becomes clearer,"

Manufacturing

Britain's manufacturing sector has been moaning about the impact the Bank's recent rate rises will have on its orders for the rest of the year.

But the situation appears to have improved in the last month, with the CBI's industrial trends survey placing the sector wholly in the 'unbothered' category after the recent turbulence.

It cites strength in the wider economy as being behind the upbeat assessment and is even happy playing down the limiting factor caused by the strong pound. Here, at least, there is no pressure on the MPC for an immediate cut in rates.

Consumer confidence

While the three main sectors may be put off their long-term progress, there is one important aspect which is definitely nosediving.

Consumer confidence ratings have taken an almighty hit after the images of worried Northern Rock customers queuing outside bank branches earlier this month.

A run on the bank is never likely to bolster people's perceptions that matters are smooth and stable and, according to research group GfK Nop's latest assessment, confidence "took a tumble" because of the crisis.

Global Insight chief economist Howard Archer said the sharp fall in confidence recorded in September was "the first clear evidence that the Northern Rock crisis has significantly affected the consumer".

He explained: "Consumers appear to have become markedly more worried about the economic outlook and less prepared to spend."

Will the Bank wait and see whether the retail property and manufacturing sectors are affected by this? The final and most important factor may suggest the answer is no.

Inflation

Having fallen to 1.8 per cent in August, the Bank does not need to open up the flow of money with a cut in the base rate. Medium-term expectations continue to be of upside pressures, but these have fallen since the August inflation report and – so far at least – the economy does not appear to have reacted wildly to the Northern Rock scare.

This week's decision could well be…

… a nervous hold. Governor Mervyn King has had a bad month, with his reputation suddenly besmirched after ten years of success. The Bank does not need to act and a hold justified on such grounds would be the perfect excuse for a convenient wait-and-see approach. The temptation may be there, but it will probably not be taken.End of story



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