Interest rates set to stay on hold

Mar 5 2008 by Alex Turner, Liverpool Daily Post

INTEREST rates are once again the focus of the markets as they wait to see what action the Bank of England’s Monetary Policy Committee takes when it makes its latest announcement at noon tomorrow.

After 0.25% cuts in December and February from its six-year high of 5.75%, the Bank of England looks set to keep interest rates at 5.25% this month.

This is backed up by the results of a Reuters poll of 65 economists which was overwhelming in its view that rates would be held. Only one of the 65 expected the MPC to approve a rate movement.

However, a further rate cut is expected within the next three months as the committee attempts to react to cautious spending and inflationary pressures in a turbulent financial market.

Policymakers were vociferous in February as they stressed the dangers that could lie ahead. The Bank must balance concerns about slowing growth against the danger that a short-term spike in inflation could lead to public expectations of higher prices becoming entrenched.

Howard Archer, the chief UK economist at Global Insight, said: "We expect the Bank of England to trim interest rates by a further 25 basis points to 5% in May.

"But it could move in April if the economy appears to be slowing sharply, wage growth remains contained and inflation expectations appear to be at least stabilising."

And Mr Archer highlighted manufacturing as a problem area as it copes with a cautious market and rising commodity prices.

“Going forward, we expect manufacturing activity to slow as it is buffeted by the credit crunch, slowing domestic demand and elevated oil prices,” he said.

Manufacturers’ data are causing concern after figures from the Charterd Institute of Purchasing and Supply (CIPS) this week showed that prices increased at their fastest rate in more than eight years as firms struggled with higher costs.

Capital Economics’ UK economist Paul Dales said: “The MPC will be very concerned that despite the clear weakening in the activity environment, price pressures are still rising.”

The CIPS survey also showed input costs driven up at their highest rate since November, 2004, by higher prices for oil, energy, chemicals, metal and plastics.

Rising food and energy prices are likely to push inflation up sharply this year and policymakers are worrying that this could become self-perpetuating as people start expecting prices to go higher and demand higher wages as a result.

The markets are currently pricing in three cuts by the end of the year and the Bank of England’s February inflation report showed that interest rates would have to fall one or two times to make sure inflation was on target in two years.

The inflation target of 2% remains a problem and is complicating the equation for the Bank of England.

The Governor of the Bank of England, Mervyn King, has previously said that the Bank faces a difficult balancing act in addressing “substantial challenges”.

Mr King has been among the most reticent of the nine MPC members to cut interest rates and since becoming Governor nearly five years ago has only voted for a rate cut when there has been a strong consensus within the Committee. But there remains the possibility, especially in the light of previous criticisms that they failed to act swiftly enough last autumn, that the MPC will decide to lower rates this week because they are going to fall at some point anyway.

MPC member David Blanchflower, who has voted for an interest rate cut in each of the last five months, wanted to cut interest rates by 0.5% last month when his eight colleagues voted for a quarter-point reduction. He argued that a bigger cut early on would preclude the need for more aggressive moves later.

But even normally hawkish MPC members have expressed concern that rates may need to be lower.

alex.turner