THE Bank of England is set to cut interest rates from 5.5% to 5.25% this week, but economists warn that the decision could be closer than has been assumed in financial markets.
The “shadow” monetary policy committee (MPC), which meets under the auspices of the Institute of Economic Affairs, votes only 5-4 for a cut this week. It has been good at anticipating actual MPC decisions.
Four of its members, Philip Booth, John Greenwood, Kent Matthews and Trevor Williams, say the Bank should cut by a quarter of a point this week while one, Peter Warburton, calls for a half-point reduction.
Of the five cutters, only Warburton has a bias towards further rate cuts. The City assumes the Bank will reduce rates several times in the coming months.
The other four voting members of the shadow MPC have different views on where rates should go next. Tim Congdon and Andrew Lilico have a “neutral” bias, Ruth Lea thinks the next move should be down, while David B Smith, committee chairman, thinks inflationary pressures mean interest rates should eventually go higher.
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Some of the intense debate on the shadow MPC is likely to be matched when the actual committee meets this week. Michael Saunders, an economist with Citi-group, said the Bank faced its most intense dilemma in more than 10 years of independence.
“We expect the MPC to cut by a quarter of a point at the upcoming meeting, coupled with a warning that rates will not fall as much as markets project unless economic data worsen markedly or financial market strains stay high,” he said.
“If our call is wrong, then it is more likely that rates are unchanged in February than cut by half a point.”
According to a survey of analysts by Ideaglobal.com, however, there is a 70% probability that the Bank will cut by a quarter on Thursday, and a 20% chance of a half-point reduction. Bank rate is expected to fall eventually to 4.5%. Analysts put only a 10% chance on a “no change” decision, which would come as a big disappointment to markets.
It would also be badly received by business. David Kern, economic adviser to the British Chambers of Commerce, said: “Global and domestic conditions have worsened since the January meeting. A cut in rates to 5.25% is now urgently needed. But this is no longer enough. To counter the mounting threats to the economy, we urge the MPC to cut interest rates as early as practical to 5%.
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“We would welcome a bold move to 5% on Thursday. But, if this is thought to be too risky, because it may be seen as signalling panic, the MPC could move to 5% in two rapid steps. It is critical, however, to avoid undue delay.
“The longer the MPC waits now, the bigger the danger that the situation would deteriorate, and the policy choices would become more difficult and more unpleasant later in the year.”
Steve Radley, chief economist at the Engineering Employers’ Federation, said: “Whilst anecdotal evidence from companies remains more positive than some of the current figures, there are significant pressures bearing down on manufacturing from a slowing world and domestic economy.
“With one eye on inflation, the MPC should head off these pressures by continuing its gradual approach and cutting rates by a quarter of a point.”