Timing is everything. If Mervyn King had delivered his ‘calm down dear’ speech just after the publication of the Monetary Policy Committee (MPC) minutes rather than just before, we’d be looking at a far different set of near-term interest rate expectations in the UK market.
As it is, the market has raced back to fully price in two quarter point cuts by year-end. Of course, we need to remember that King’s speech did take place after the crucial MPC policy meeting where two members voted for an immediate rate cut – a move in which King himself was clearly not interested.
The 7-2 vote split was a big surprise to the market (and to us) with short sterling futures quickly returning to price in a near-term cut (probably August) with another quarter point move discounted after that. We still believe this is premature.
The Bank has shown consistently that it will act in response to the data flow. So should negative news dominate the coming month or so, the MPC will cut rates and we’ll be wrong.
But just as we thought it was wrong to predict a hike on the basis of Tucker and Large voting for it in February and March (with Large still going for a quarter point rise in May), we think it is wrong to get too excited about a near-term cut. The only important thing is the data.
And we continue to expect somewhat better consumer sector reports to negate a rate cut in the near-term. We still forecast a quarter point cut in November.
Risks to inflation
Two MPC members voting for a cut is quite a turnaround in the space of a couple of months – when two voted for a quarter point increase. It is clearly a significant development along the road to confirming the next move in rates to be down.
But there are a number of interesting points we think are worth drawing out here with regard to timing. King’s comments contrived to draw into focus some of the upside risks to inflation and the potential for a mini-revival in consumer spending in the coming months.
The market reacted, predictably, by pushing out its expectation for a near-term hike. Not that there was anything especially new in what King was saying but his decision to articulate such risks was the important thing and was probably motivated by a reluctance to see the market going too far down the rate cut road too soon.
And given that King will have been acutely aware of the market’s impending reaction to the release of the ‘dovish’ MPC minutes this week, his comments are given even greater clarity.
Of the two MPC members who voted to cut rates, the most important is Charlie Bean. Marian Bell’s term ended with the June meeting. David Walton replaces her and his focus is likely to be on finding his feet in terms of the Committee’s dynamics rather than seeking to differentiate himself in his first meeting.
Charlie Bean’s departure from the ‘core’ Bank view is more relevant than most because as the Bank’s chief economist, he is responsible for the official forecast.
Of course, outside of the quarterly forecasting cycle, Bean’s conclusion for policy will not have the same impact as it might have if it had been backed-up with a revised inflation report forecast, so in our view we are still left looking at the data flow if Bean is to be able to carry the rest of the MPC with him next time around.
And in that regard our analysis of households’ income growth, the evidence on mortgage borrowing (which has improved for the past five months) and durable goods spending (especially household goods which has rebounded) still suggests there’s enough in the tank to finance reasonable consumption growth over the coming months.
Steven Andrew is an economist at F&C Asset Management plc
