(UK Forex) Policy Decision Getting Tougher For MPC

What is the MPC to make of what is going on? It has seen a widening of interbank interest rate spreads in the last month, increased volatility in equity and foreign exchange rate markets and rising oil and commodity prices that are boosting inflation pressure. It is no wonder that at the March interest rate meeting there was a split, with 7 voting to leave rates at 5.25% and 2 voting for an immediate cut of ¼%. Moreover, the actual minutes from that meeting highlight the dilemma now facing the MPC. On the one hand, a further tightening of credit conditions could result in growth slowing more sharply than expected in the central projection – this would reduce medium-term inflation risks and so argues for lower rates.

MPC unsure about what to do…
What is the MPC to make of what is going on? It has seen a widening of interbank interest rate spreads in the last month, increased volatility in equity and foreign exchange rate markets and rising oil and commodity prices that are boosting inflation pressure. It is no wonder that at the March interest rate meeting there was a split, with 7 voting to leave rates at 5.25% and 2 voting for an immediate cut of ¼%. Moreover, the actual minutes from that meeting highlight the dilemma now facing the MPC. On the one hand, a further tightening of credit conditions could result in growth slowing more sharply than expected in the central projection – this would reduce medium-term inflation risks and so argues for lower rates. On the other hand, further rises in commodity prices, compounded by the weaker pound, coupled with elevated inflation
expectations mean that there are upside risks to inflation in the medium term, despite slowing economic activity, implying that rates should remain on hold at best. The
charts in this publication, from a to e, give the source and sense of this better than expected economic performance, the rise in price inflation pressure and the threat from higher inflation expectations.

 

So what is the MPC to do? The answer, in our opinion, for the next meeting in April is nothing. Our monthly monetary policy checklist actually suggests a very contrarian view: that based on the data available since the last MPC meeting there is a slight bias to raise rates. Now, this is not going to happen, but it does show that unless a lot of the downside risks that many are expecting do not start to appear soon, the next move in interest rates may not be downward but sideways for many months and then up when the credit crisis eases. …so left interest rates at 5.25% in March…
The minutes of the March meeting said that the majority on the MPC think that: ‘Both the manufacturing and services CIPS/NTC activity measures picked up in February, and, together with January’s data, suggested that output growth in the first quarter might be a little above the level expected at the time of the February Inflation Report.’ The committee went on to add that, ‘There was little evidence that the downside risks to inflation from a sharper-thanexpected slowdown in activity, flagged as a risk in the February Inflation Report, had begun to crystallise.’ However it did note that: ‘… the impact of the deterioration of credit conditions remained very uncertain’. Overall, however, these quotes do not suggest a committee that is about to cut interest rates, though the minutes did say that: ‘…the central view was predicated on the assumption of some further modest easing of Bank Rate…’ With this in mind what have the data since the last MPC meeting showed about the economy, especially as the minutes said that not enough had changed in March to justify a rate cut and that the committee would focus on reviewing new economic information each month for the implications for the inflation target in the medium term?

 

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