BoE Minutes Leave Door Wide Open For Deep December Cut

The BoE's decision to slash the Bank rate by 150bps in early November was carried by a unanimous vote, according to the minutes to that meeting released today. Highlighting the need for "substantial monetary loosening", the minutes---together with the  extremely bearish Inflation Report (IR) published last week---signalled the MPC still believes it has a whole lot of unfinished business to get through in terms of rate easing in coming months, in our view.

The MPC's meeting in early November occured against a backdrop of a substantial shift in the BoE's outlook for the economy and inflation, as highlighted in last week's IR. Just how substantial the shift was is highlighted by the fact that, back in August, the BoE's 'fan chart' for all conceivable outcomes on GDP essentially viewed the new November projection for GDP---a decline of 2.0% yoy by early next year---with zero probability.

As justification for the sea-change in the BoE's GDP and inflation forecasts, the MPC noted that 3 factors had transformed the outlook between the early October meeting and November. Firstly, the global banking system experienced its biggest crisis in almost a century. Secondly, there had been a further marked fall in economic activity indicators, both domestically and abroad, in the wake of the virtual collapse of financial markets. Finally, commodity prices, in particular energy prices, had plunged since mid-July. These developments made "a strong case" for an immediate cut of "at least" 100bp in the committees' view.

Most extraordinary, the minutes recorded that the MPC interpreted the new Inflation Report forecasts---notably, that inflation would plunge to 1% next year even if the Bank rate fell a little below 3%---as implying a significant cut "in excess of  200bps" might be immediately required to get inflation back to the 2% target in the medium term. 

However, the MPC  marshalled a number of arguments against such a huge cut. The main concern revolved around just how large the government's fiscal stimulus would be in the November 24th Pre-Budget Report. In last week's press conference, King had given a green light to a modest and temporary stimulus. We suspect that tax cuts and higher public spending worth around 1% of GDP (around £15bn) would leave the MPC feeling it had a free hand on lowering interest rates. A meaningfully larger stimulus than that would likely be seen as a constraint to further aggressive easing, in our view.

The MPC also noted that there was a lot of uncertainty on the impact of the global bank bailout packages on the flow of credit into the real economy. The year-end funding squeeze is likely to blur the picture on how much the financial markets have recovered until early next year, in our view. A further big concern for the MPC was shocking markets too much, which could end up posing upside inflation risks if sterling fell too fast. It was also noted that "some members"---not all---felt that they should conserve their ammunition and leave some cuts for the months ahead to support confidence as the economy continues to contract. 

The conclusion that some of the required loosening should be left until "after the Committee had an opportunity to explain its change of view on the outlook for inflation in the November Inflation Report and to assess the market reaction to both the Report and the decision" would seem to suggest a 50bp ease to 2.5% at the December 3-4th meeting is probably a bare minimum. With the market currently pricing in around 80bp of easing for the December meeting, CPI inflation falling much more than expected in October already to 4.5% and amid growing gloom about the global economic outlook, we continue to believe that the MPC will need to effect another deep cut next month. We are looking for a 100bp cut to 2.0% already, notwithstanding the MPC's desire to keep back some of of its firepower to support confidence in coming months. With Governor King promising last week to take rates down to "whatever level is necessary" to combat deflationary forces in the economy, we believe the Bank rate will fall to a 1.5% trough early next year. We see a small but growing chance that the trough in rates could be even lower at 1.0% by mid-2009.

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