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BoE Mulled an Even Bigger Cut in December But Held Back on Sterling Fears |
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17.12.08 13:31 |
| | | BoE Mulled an Even Bigger Cut in December But Held Back on Sterling Fears
The Bank of England is nowhere close to calling it a day as it battles to cushion the economy from a severe recession and prevent disinflationary forces from becoming persistent.
The minutes to the December 3-4th MPC meeting revealed a unanimous vote for a rate cut of "at least" 100bp, to 2.0%, so worried were members about the economic outlook. Acknowledging a synchronised global economic slowdown, the MPC noted that business surveys had continued to deteriorate into 4Q and that consumption and business investment had "stalled". The committee warned that "a mapping from the surveys into GDP suggested falling output in both 4Q 2008 and 1Q 2009." Overall, the MPC concluded that "the medium term outlook for inflation appeared to have shifted downwards since the November Inflation Report", a clear signal that further rate easing was on the cards, in our view.
This conclusion was further reinforced by the discussion of whether an even larger rate cut than 100bp was required. However, the minutes noted a number of counter-arguments, principally that markets had priced in 100bps of easing and anything larger than that could cause an "excessive" fall in the exchange rate. MPC members also expressed concern about moving into unchartered territory. The minutes note that the Bank Rate had already been reduced from 5% to 2% in the space of 8 weeks and that, given the uncertainty in how effective the monetary transmission mechanism was, "it was difficult to be certain that rates needed to be cut by more or faster than that."
The MPC acknowledged the limits to the effectiveness of traditional monetary policy in the current environment. It may be a stretch to interpret this as the first public hints of possible quantitative easing policies as already adopted by the Fed. Still, the committee agreed that "Bank Rate was not the right policy instrument to tackle supply constrains in the credit market" and that "further measures to underpin lending growth would be needed, building on the Government's package announced in October to recapitalise and guarantee funding to banks."
The MPC spent some time mulling over the impact on inflation of the Government's fiscal stimulus package, in which the temporary 2.5 percentage point reduction in the VAT rate to 15.0% formed a cornerstone. As already highlighted in Governor King's letter to the Chancellor yesterday--explaining the ongoing divergence of headline CPI inflation over the 2% BoE target by more than 1 percentage point--the MPC appears prepared to "look through" the likely volatility in inflation caused by the change in the VAT rate i.e. on balance, relatively lower inflation in 2009 to be replaced by higher inflation in 2010. As a result, there appears to be no impediment to further aggressive easing from the BoE, save concerns about its possible impact on the sterling exchange rate.
Separately, labour market data reveal worrying deterioration in the labour market. In November, jobless claims surged 75.7k, much higher than the 44.0k expected. This was the biggest monthly rise since March 1991. Claims have now risen for the past 10 months, the worst such stretch since the early 1990's recession. With the number of people claiming benefit so far this year leaping 280k, the total number of individuals on benefits has now risen above the psychological 1mn mark (to 1.072mn last month) for the first time in 8 years. The separate, international comparable ILO measure, revealed that the unemployment rate had risen to an 8-year high of 6.0% in October from 5.8% in September. As the economy moves deeper into recession in coming months, we expect to see even more rapid rises in unemployment. By the end of next year, the unemployment rate is likely to have risen to at least 8.5%, according to our forecasts, implying a further 800k individuals becoming unemployed, which would increase the total number of people without a job to around 2.7mn, in our view.
We currently expect that the BoE will cut the Bank rate 50bps in both January and February, to a trough of 1.0%. We see a growing chance that the BoE will cut a full 100bp, to 1.0% in January. Under this alternative scenario, rates may reach a trough below 1%, possibly close to 0%, during 1Q 2009 at which time the BoE could then begin to implement non-traditional forms of monetary policy in the shape of buying mortgage-backed securities and gilts as it attempts to reflate the economy.
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