Tuesday, January 8, 2008

UK Economic Uncertainty Gives Hope for Rate Cut

Uncertainty over the extent of the economic slowdown is expected to persuade the Bank of England to resist calls for an immediate further cut in interest rates when its monetary policy committee meets on Thursday.

A Reuters poll of economists last week showed that only 12 of 63 surveyed expected a rate cut this week although a larger number expected that the MPC would move rates lower in February following publication of its next inflation report.

"Our overall sense is that they probably will hold off [from cutting rates]," said Jonathan Loynes, economist at Capital Economics, noting that rising energy prices, and their knock-on impact on inflation, were likely to give MPC members pause for thought.

Last week, NPower, the gas and electricity supplier, announced it would increase prices by an average of 15 per cent, a move expected to be followed by its competitors in the industry. Rising energy prices have loomed large over central bankers in several economies, raising the spectre of inflation even as domestic growth stutters.

Inflation, Mr Loynes noted, remained a widespread concern. In a weekend interview, Gordon Brown, the prime minister, admitted more needed to be done "to break the back of inflation". He has vowed to limit public sector pay rises to below 2 per cent.

Moreover, it is not yet clear to the MPC that wage inflation is abating in response to slower economic growth. For example, the latest survey from Income Data Services showed a pick-up in pay rises last month to 4 per cent from 3.5 per cent, albeit from a relatively small number of pay deals. Far more crucial will be pay settlements agreed over the next three months which form the largest segment of salary deals. Meanwhile, Ben Broadbent, economist at Goldman Sachs, said that the economic data so far were not sufficiently gloomy to lead the MPC to conclude that a rate cut was needed right away. For example, the purchasing managers' index of business activity, on balance rose slightly last month and the key services segment showed a modest overall rise.

Even the credit conditions report from the Bank, issued late last week, offered some ambiguous messages on the economy. While secured lending to households - mortgage loans - had slowed sharply since the last survey and was expected to continue to do so, it was not clear that that was because applicants were being turned away.

Mr Broadbent said that the fall in new buyer inquiries, highlighted in the latest survey from the Royal Institution of Chartered Surveyors, suggested the drop might reflect falling demand from house buyers rather than a tightening of standards by lenders. In effect, it was not clear that home buyers were being squeezed so badly that the overall economy was in danger today, he said.

George Buckley, economist at Deutsche Bank, noted that another factor delaying a rate cut might be that although lending to households on a secured basis had tightened, it had done very little for unsecured lending - via credit cards, for example. That would suggest that consumers wanted to keep on spending.

Mr Buckley said he believed the next inflation report would give the MPC scope to cut rates, noting that historically, it was twice as willing to move rates up or down following publication of such a report than it was without one.

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