Later today (at noon, to be precise) the Bank of England will announce its latest decision on interest rates.
So what’s it going to do? The question is a lot harder to answer this month than we’ve been used to for the last few years. Recent economic data on the UK has been nothing short of dreadful.
But, at the same time, inflation is above target and it’s likely that governor Mervyn King will have to get his biro out more than once this year as CPI overshoots the upper limit of 3%, forcing him to write a letter to the Treasury explaining why.
So it’s hard to say whether rates will stay put or fall. But more to the point, whatever the Bank does, will it make much difference to anything?
The economy is in even worse shape than feared
Until this week, the consensus was that the Bank of England would keep interest rates on hold this month, then probably cut them next month. Now markets aren’t so sure. The pound fell sharply against both the dollar and the euro yesterday, as economic data suggested the economy is in even worse shape than feared.
Manufacturing output fell 0.5% in March, the biggest decline in six months, rather undermining the notion that the UK can economy can be saved by that much-neglected sector. Meanwhile, Nationwide reported that consumer confidence is at its lowest since the building society began producing the survey in May 2004. That’s not a terribly long time to be fair, but do remember that summer 2004 was when the property market had its little blip which the bulls had hoped would be duplicated this time round.
More worrying was news earlier this week that service sector activity is slowing sharply. With the vast majority of the UK economy dependent on services, any slowdown or shrinkage will hit us hard. This of course, is inevitable. People don’t have as much money as they did, and with estate agents, City banks and builders already slashing jobs, it won’t be long before the impact of rising redundancies starts to be felt in earnest on the UK high street.
This is all bad news for the economy. But bear in mind, that unlike the Federal Reserve, the Bank of England specifically has to fight inflation. Right now inflation is above target (2.5% according to the consumer price index (CPI)). And although the Bank might suspect that a shrinking economy and falling house prices could put a lid on it, that’s not something it can rely on right now.
With oil prices hitting new records every day (Goldman Sachs now reckons we could see a ‘super-spike’ to $200 a barrel), and food prices doing the same, trying to argue that inflation’s not a problem just won’t wash. Given that the Bank’s job is so specific – to keep CPI at 2% – it’ll be hard for the Monetary Policy Committee to justify cutting rates without acknowledging that the economy is in a truly awful state.
But the bigger question is – what difference will a cut in rates make? Well, it won’t help house prices. Banks are now no longer interested in splashing money all over the housing market, so interest rates on new mortgages will keep rising or stay static pretty much regardless of what happens to the base rate. And in any case, with prices now clearly falling, any sensible buyer will stay firmly out of the market, regardless of what the banks are offering.
Hamish McRae in The Independent argues that “cuts in rates, however, are not intended to rescue house prices; they are to rescue the economy.” He acknowledges that there will be “quite a painful adjustment in household spending” as Roger Bootle has pointed out. “But then we have over the past decade experienced the fastest growth in overall demand of any of the major developed economies… the three or four slim years would follow a decade of fat ones.”
I’m not meaning to pick on Mr McRae specifically here, but his views sum up nicely the general feeling that still exists among mainstream economists. This is the idea that things won’t get that bad. After all, the housing market’s not the be all and end all of the UK economy, is it? And we have had a long period of growth – it had to slow down sometime, didn’t it?
It’s too late to save the economy from recession
The trouble is, this long period of growth was an illusion built on debt. Consumers have spent too much, and the government has spent too much. Both of those trends are now ending. Consumers no longer have access to cheap debt, and the government will have to tighten its belt too, particularly with so many big companies threatening to take their taxes elsewhere.
And cheaper money won’t help. That’s partly because the cheap money won’t make its way to consumers, but mainly because the massive bubble that’s now exploding, was caused by cheap money in the first place.
So cutting interest rates won’t stop the economy from heading down into recession. What it will do is weaken sterling. And that will make the impact of high commodity prices even worse as sterling weakens against the dollar. So, like it or not, a rate cut today would be inflationary, and probably should be avoided.
That doesn’t mean it will be of course. But I suspect that Mervyn King will be putting up quite a fight this month to keep rates on hold.
Turning to the wider markets…
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On Wednesday the FTSE 100 index gained 46 points to close at 6261.
After recent weakness, housebuilders recovered on rumours of imminent takeovers despite recent downbeat results. And pub owners were the day’s top dogs after a Revenue and Customs ruling that Enterprise Inns, up almost 30%, could adopt REIT (Real Estate Investment Trust) status, prompting large rises across the sector. But other leisure stocks fared less well, with bingo hall operator Rank dropping nearly 6% following an unimpressive half-year trading statement.
In Euroland, the German Xetra Dax advanced 0.8% to 7076 while in Paris the CAC index put on 0.7% to 5075. French cement maker Lafarge climbed 5% after better-than-expected first quarter profits, while miner Eramet added 6%.
In contrast, Wall Street’s Dow Jones Industrial Average tumbled over 200 points, closing at 12814 on concerns about inflation as oil prices jumped to a record high above $123/barrel. Both the broader S&P 500 and the tech-heavy Nasdaq lost 1.8%.
In Asia overnight, Japanese stocks followed the US lead, with the Nikkei 225 shedding 0.6% to close at 13943. In Hong Kong, the Hang Seng was down 1.1% at 25463.
Brent spot was trading this morning at $121.66, while spot gold stood at around $866. Silver was trading at $16.50.
Turning to forex, this morning sterling was lower at 1.9531 against the US dollar, but was firmer against the euro at 1.2745. The dollar was last trading at 0.6521 against the euro and 103.87 against the Japanese yen.
All eyes today will be on interest rate decisions to be made by the Bank of England and the European Central Bank.
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