Interest rate monitor - February
Inflationary pressures are proving a headache for the MPC
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Monday, 05, Feb 2007 10:45
On Thursday February 8th the Bank of England's monetary policy committee will announce the outcome of its monthly meeting deciding whether to lower, hold or raise interest rates. We assess the current economic situation to work out what might be running through the minds of its nine members in the run-up to this month's meeting.
January's decision
In a shock decision last month the MPC voted to raise interest rates by a quarter of a per cent to 5.25 per cent. The move caught the majority of economists on the hoof; with most predicting that with a lack of reliable retail sales data available, the Bank would hold on any rises until February at the earliest. Minutes released after January's decision revealed that the committee was wholly divided over the increase, however, with four members voting to hold rates. The partition in the MPC makes forecasting February's decision problematic, but successive rate rises would confirm without a doubt that the Bank was failing to address overheating fears. But with inflation hovering dangerously close to the 3.1 per cent that would require the Bank's governor to write to chancellor Gordon Brown explaining just what was going on, an increase to 5.5 per cent is, as ever, possible.
Pundit predictions
On a sector by sector basis, increasingly wary economists have spent January mostly sitting on fences after being caught off guard by the Bank, but the overwhelming feeling is one off 'surely not again'.
Retail
Traditionally retailers represent the most vehement opposition to interest rate rises, and the sector may again have cause for concern this month after surprisingly healthy Christmas sales figures emerged after the Bank's January rate rise.
Total sales during last December was 3.7 per cent higher than in the 2005, the Office for National Statistics revealed.
Predictably, the British Retail Consortium (BRC) was not impressed with the MPC's decision last month, accusing five of its members of over-reacting.
"This is an unnecessary blow. The effect of the November rise has not yet worked through to household spending and, coming so soon after, another rise will hit consumers hard," said the trade association's director general Kevin Hawkins.
Property
Britain's vibrant economy in recent years has its foundations in pay increases, high employment rates and relentless house price growth. But the most recent house price index from Nationwide shows that seasonally-adjusted house prices rose by 0.3 per cent in January - the lowest monthly increase experienced since May 2005.
These statistics followed data in December that revealed house prices had actually fallen.
Nationwide's chief economist Fionnuala Earley predicts that house price growth will remain steady over the coming half-year in spite of steady interest rate rises, but believes that the most likely scenario in February, albeit "by a tiny margin", is that rates will remain at 5.25 per cent.
"Earlier rate rises have still to fully feed through into the economy as squeezed disposable income contributes to weaker consumer spending," she said.
Manufacturing
While in previous months faltering manufacturing demand was seen as a direct result of the MPC's rate increases, in January the sector imitated the committee by producing some surprising results of its own.
The Confederation of British Industry (CBI) revealed last month that British manufacturers experienced their strongest quarterly rise in output orders since 2004, while growth in output volumes hit at 12-year high.
CBI chief economist Ian McCafferty concedes that this growth is indicative of inflationary pressures upon the economy, but at the same time insists that it remains a short-term factor.
"The MPC will need to consider the medium-term outlook, which will involve the impact of the interest rate rises already in place, the strength of sterling and its impact in inflation, as well as the results of the forthcoming pay round. The effect of these is not yet clear," he said.
Consumer confidence
In a month of surprises, consumer confidence in January - never the most upbeat of months - actually rose.
But the picture of shoppers cart wheeling down gold-paved high streets is quickly dispelled by the fact that GfK NOP's barometer still stands at minus seven, four below last year's reading.
Carol Bernasconi, the research firm's division director, explains that the underling trend in the index "is still not one of optimism".
"This month consumers may have been surprised by the rise in interest rates, their feeling about personal finances and the general economic situation is less optimistic than last month," she said.
Nationwide meanwhile predicts that there is a 90 per cent likelihood of rates staying the same this month after its own index fell one point to an all-time low.
"The MPC will look closely at the labour market for signs of wage inflation," a spokesperson said.
Inflation
Inflation rose 0.3 percentage points to three per cent in December, precariously close to the 3.1 per cent level that would require the Bank's governor to write a 'Dear Gordon' letter to the chancellor to explain, ultimately, why the MPC was failing to control inflationary pressures.
The government's overall target is two per cent and, as previously mentioned, with retail and manufacturing sectors both experiencing surprising new year growth, it is likely that inflation will go up once again once January's data is available.
Howard Archer, chief UK and European economist at Global Insight, admits that the present economic climate is both exciting and challenging for analysts trying to second guess the MPC.
"This reflects the fact that after an extended period of relative tranquillity, the UK economy has sailed into rougher seas than it has experienced for some time and is facing higher inflationary waves," he said.
"January's shock interest rate and news that consumer price inflation had jumped to three per cent in December. suggested that it is very possible that the Bank of England could enact back-to-back interest rate hikes by moving again in February.
"However, we believe that it is more likely that the Bank of England will delay acting until March," Mr Archer concluded.
So February's decision could well be.
. There are some very mixed messages emerging from the Bank in 2007 so far, with four MPC members not happy with a quarter of a per cent rise despite evident inflationary pressures.
Mr King will be desperate to ensure that inflation does not exceed the three per cent watermark, and with employment and pay levels showing no sign of abating, the criteria for a successive monthly rise to 5.5 per cent are all present.