Bank of England expected to hold interest rates

Another great article by Gary Duncan on the likely future direction & timing of changes in interest rates.

Gary Duncan, Economics Editor

When the Bank of England’s ratesetting Monetary Policy Committee (MPC) gathers again this week in Threadneedle Street, the economic picture it confronts might be summed up as “the only way is up” — and in more ways than one.

Since the MPC last met a month ago, startling official figures have revealed that the economy plunged in the first quarter at an even more savage pace than had been believed, with GDP plummeting by 2.4 per cent, compared with the 1.9 per cent fall previously reported.

Yet the burgeoning conviction in the City, and the hope at the Bank, is that this will mark the worst phase of the recession and that the slump has since bottomed out.

An accumulating slew of evidence suggests that the quarter just ended will be far less brutal and that a return to growth, albeit of an insipid sort, is impending.

This leaves little doubt, too, that the next move for interest rates will be upwards, from their present, 315-year low of 0.5 per cent. But with Britain’s recovery prospects still fraught with uncertainty, any such move remains a long way off, perhaps as far off as 2011.

The clouded picture of a sharper downturn in the past, hopeful signs of an emerging upturn and worries over how strong an economic revival lies ahead also leaves much of the City concluding that a move up is also on the cards for the scale of the MPC’s radical quantitative easing scheme.

Many economists think that the Bank will opt to further raise the scale of its purchases of government and corporate debt under “QE”, through which it is trying to transfuse newly created money into the economy.

The Bank has completed an estimated £106 billion or so of the £125 billion asset purchases ordered by the MPC. Analysts think that this month it could order the use of the remain-ing £25 billion of purchases allowed within a £150 billion maximum set by Alistair Darling.

Some think that the MPC might also ask the Chancellor’s permission to extend QE further, although most believe that, even if it seeks this authority, it is unlikely to use it until next month, when the Bank will have completed its latest quarterly forecasts.

Here is our monthly guide to the issues that the MPC must weigh up.

Growth and activity: picking up A raft of data has pointed to the economy having begun to recuperate. Among the most encouraging signs have been key CIPS/Markit purchasing managers’ surveys showing that the services sector expanded last month for a second month in a row, while manufacturing continued to contract, but at the slowest pace for 13 months.

Official manufacturing data for April showed the first rise in output, by 0.2 per cent, since February 2008.

Optimism that the housing crash may be ending has also been lifted by reported rises in house prices, with Nationwide Building Society detecting a 0.9 per cent June increase on the heels of a May rise of 1.3 per cent.

Serious anxieties remain, however. Consumer demand is a central concern, with spending power under severe pressure from rising unemployment and a squeeze on pay. Official retail sales volumes fell by 0.3 per cent in May and the CBI’s snapshot of high street conditions in June was also disappointingly anaemic.

The jobless toll from the recession keeps climbing, even if at a slower rate, with a further 39,300 people joining the dole queues in May, although this was the lowest number for ten months.

Costs and prices: proving sticky Worries over inflation have re-surfaced, despite the retail price index showing the cost of living tumbling at an annual 1.1 per cent pace in May. Consumer price inflation remained stubbornly above the Bank’s 2 per cent target, at 2.2 per cent, boosted by the rising cost of imports thanks to a weak pound. Sterling has clawed back ground in recent weeks, however, with its overall value up almost 6 per cent over the past three months.

Signals from pay are mixed, with headline average earnings growth at a modest 0.8 per cent in April. but unit wage costs up sharply as plunging output undercuts productivity.

International economy: nagging fears Hopes have continued to rise that the worst of the deepest global slump since the Second World War is over. In its latest assessment, the Organisation for Economic Co-operation and Development revised up its forecasts for the developed world for the first time in two years. But big fears remain, notably over the eurozone, the still fragile state of banks and persistently tight credit conditions.

Rates verdict: Interest rates are on hold indefinitely. A further expansion of quantitative easing is very likely. (Gary Duncan, The Times).

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