The chances of a rate cut at the Bank of England’s meeting on Thursday are balanced on a knife edge, at least according to the markets. Implied probabilities in option prices forecast a 45 per cent chance of a 25 basis-point rate cut by the central bank’s nine-strong rate setting committee and a 55 per cent likelihood that rates will remain at 0.75 per cent. The most sensible course for the BoE is to wait and see whether the post-election bounce in sentiment and business confidence feeds through into the economy.
Sterling was dealt a blow this month when policymakers raised the possibility of cutting rates. Three external members of the Monetary Policy Committee who are widely seen as doves — Gertjan Vlieghe, a former hedge fund economist, Silvana Tenreyro, an academic, and former Citigroup economist Michael Saunders — all indicated that they were prepared to vote for a cut.
The most influential remarks came from Mark Carney. In a speech about the central bank’s lack of tools to fight any future recession, the outgoing governor said there was a case for cutting rates soon, “if evidence builds that the weakness in activity could persist”.
Doves looking for a reason to cut rates can point to weakness last year. The available evidence suggests that the UK economy ended 2019 in either stagnation or contraction. National income grew just 0.1 per cent in the three months to November and contracted within the month itself. Overall data has not yet been published for December but retail sales fell compared with the previous month.
The most convincing argument for a rate cut is the low level of inflation. Last year the consumer price index rose by 1.3 per cent, far below the Bank of England’s 2 per cent inflation target and the lowest pace of price growth for three years. Hawks on the committee who predicted rising wages would inevitably lead to higher inflation appear to have been mistaken.
However, the role of the central bank is not to target the current rate of inflation but the pace of price growth over the next two years, and the labour market is still healthy despite weak growth in output. While the economy may have stagnated in the final quarter of 2019, the UK added 208,000 jobs in the three months to November — roughly double the pace of employment growth forecast by City economists.
Meanwhile, average weekly earnings grew at an annual pace of 3.2 per cent, slower than July but still above the rate of inflation. With labour productivity growth showing no signs of returning, companies may, finally, have to pass higher wage costs on to consumers.
Doves may still point out that labour market data is “backward looking”. It is a guide to how the economy used to be rather than how it will look over the next few years. Mr Saunders, in his remarks, pointed out that the slowdown in business investment since the Brexit vote is likely to lead eventually to job cuts.
Since the convincing victory for the Conservatives in the general election business and consumer confidence has rebounded. The flash purchasing manufacturers index, published last week, pointed to a sudden improvement in private sector sentiment. Data from the lobby group UK Finance pointed to a sharp rise in mortgage approvals, while the Nationwide Building Society found an increase in house prices.
With evidence on both sides the most sensible course is to hold fire and see if this confidence persists. The sense of relief may evaporate if EU trade negotiations become mired in disagreement. Traders are right that the arguments are finely balanced. The Bank of England should not rush to judgment.
Source: Economy - ft.com
