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Monetary−policy meeting at the Bank of England

Tue, Feb 5 2008, 10:41 GMT
by Morten Lykke Pedersen

Jyske Bank

Interest-rate announcement

Current interest rate level: 5.50%

• • The inflation rate is above the BoE's target
• • Higher-than-expected Q4 growth.

• In favour of 25 bp cut:

• • PMI the lowest it has been since 2005
• • Growth expected to slow in 2008
• • High short-term inflation perhaps less important than growth

At its monetary-policy meeting in January, the Bank of England (BoE) chose to leave interest rates unchanged. However, the minutes of the meeting at the monetary-policy committee and the latest economic data indicate that interest rates will be lowered again after the quarter-point cut in December.

Lately the inflation rate has been hovering just above the BoE's target, and this picture was unchanged in January. Moreover, the growth rate for the last quarter was higher than expected which, together with the inflation rate, indicates that interest rates will be left unchanged. However, PMI Manufacturing was the lowest it had been since August 2005, and growth in 2008 is expected to be significantly lower than in 2007. Also, we find that the inflation risk is short term. Other things being equal, the weak PMI supports expectations that the BoE will lower interest rates at the meeting next week. Moreover, in our view the prospect of slower growth will carry more weight with the members of the monetarypolicy committee than the risk of higher inflation for the short term. Overall, it means that we expect the BoE to lower interest rates by 25 bp.

Market participants have fully discounted an interest-rate cut of 25 bp, and if the BoE does not deliver, it will be a great disappointment. Probably the BoE like the Fed will be wary of disappointing the markets, which could cause a fall in equity prices and renewed financial turbulence. Market participants expect more interest-rate cuts in 2008 and discount a Base Rate of around 4.75% at mid-2008. The BoE would have to be surprisingly negative about interest rates before market rates fall from their current level.

Since the credit crisis exploded in August, GBP has been hit hard because of a softening housing market, generally poorer economic indicators and the problems over Northern Rock. Interest rates have been falling over the period, and at one time we wondered whether any more misery could be discounted in the yield curve and the currency. The answer came at mid-January, and towards the end of January, GBP was trading in a relatively narrow range, with the EUR/GBP rate at between 73.88 and approx. 75. M&A activities played a role in the narrow range trading, and we are convinced that GBP may well weaken further. Even so, we maintain our neutral short-term view on GBP, since the EUR/GBP rate has difficulties in breaking out of the above-mentioned range.

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Published on  Tue, Feb 5 2008, 10:46 GMT