How are the new Bank of England members likely to vote?

Gordon Brown has finally appointed two new members to the Bank of England's Monetary Policy Committee. Unsurprisingly, analysts believe this may lower the odds of the Bank voting for an interest rate hike. But against a backdrop of soaring oil prices and rising interest rates in Japan, can rates really remain on hold in the UK?

By John Stepek

published 10 October 2007

in Features

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The oil price just keeps surprising the sceptics.

The US hurricane season has barely begun, but the cost of black gold has already hit a fresh record. A barrel of crude is now trading at over $78 a barrel in New York, while Brent crude is trading at more than $76.50.

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Israel's bombing of Lebanon and attacks on pipelines in Nigeria are being blamed for the latest surge in energy prices. Tony Nunan, risk manager at Mitsubishi went as far as to say: 'Geopolitical risk is out of control.'

But we would argue that unless you are a deity of some sort, geopolitical risk is always out of control. As we always point out, the world - and the Middle East in particular - is rarely a stable place.

The fundamental reason for oil prices being high is the simplest in economics - there just isn't enough to go round...

Demand for oil just isn't falling, despite record prices. A report from the US Energy Information Administration shows that Americans used more gasoline (petrol) in June than in any other month this year. That's despite the fact that the price of filling a car - even after accounting for inflation - is close to the highest it's ever been.

And with car sales in China soaring by nearly 50% in the first half of 2006, there are plenty of gas-guzzlers just waiting to take up the slack, even if US drivers start to cut back.

As energy trader Nauman Barakat told CNN, if geopolitical problems calm down 'we could head back to around $70. But fundamentally, it's difficult to make a bearish case.'

There's an ongoing debate within the oil industry that has spilled over onto the front pages over the past year or so. Proponents of the Peak Oil theory suggest that we have reached, or are about to reach, the point where production from the world's major oil fields has 'peaked'.

In other words, we're getting as much oil per day out of the ground as we ever will - and it's downhill all the way from here.

But what about alternative sources, like Canada's oil sands? Or coal-to-liquids technology? Or oil shale (for more on these alternative oil sources, you should browse the commodities section on our website - just click here: Investing in commodities.

Those who point to alternative sources have a good point - but the trouble is, none of these sources will come on stream in time to save us from a difficult few years ahead. To learn more about this, click here: Why Peak Oil has no effect on oil prices.

In the short term, the US driving and hurricane seasons are just getting underway, and the situation in the Middle East looks set to get a lot worse, before it gets better. The odds on the oil price going higher over the summer look very likely. And if that's the case, it would be wise to position your portfolio to take advantage of this - or at least to defend your wealth against the impact of rising costs. To read more on this, click here: How to profit from soaring oil prices.

While the rise in the oil price was utterly predictable, the surprise news yesterday was that the Chancellor has finally seen fit to appoint not one but two new recruits to the Bank of England's interest-rate setting Monetary Policy Committee.

The Bank will now go into its October rate-setting meeting with a full complement of nine members for the first time since March. Both men - British Airways chief economist Andrew Sentance and London School of Economics professor Timothy Besley - are well-respected by economists and the City, which hasn't always been true of past MPC candidates.

However, the MPC's recruitment process has been criticised recently by a number of commentators, including the Bank's Governor, Mervyn King himself. Four of the nine members are directly appointed by the Treasury - and the way in which new members are chosen is far from transparent.

It has been argued in the past, by ourselves and by others, that the Government and Gordon Brown in particular might have more than a slight interest in seeing interest rates fall.

At a time when the Labour Party is constantly in the headlines for all the wrong reasons, Mr Brown must surely hope that more cheap money would enable the 'feelgood factor' (otherwise known as 'the house price bubble') to continue - at least until he moves into the Prime Minister's seat and leaves the poisoned chalice of the Chancellorship to someone else.

So how are the new members likely to vote?

Well, as luck would have it, Mr Sentance, chief economist at British Airways, has a track record. He has been on the shadow MPC of The Times.

And surprise, surprise, his voting record for the newspaper suggests that he's something of a dove when it comes to interest rates, supporting quarter point cuts in March and April.

We have no directly comparable data for Professor Besley, a former tutor of the Treasury's Ed Balls. But we'd take a wild guess that he'll be in no hurry to raise rates himself.

Of course, if oil prices rise as rapidly as we believe they will, the new members may find they have little choice.

And with the Bank of Japan finally ending its Zero Interest Rate Policy (ZIRP) this morning with a quarter point hike in the country's key interest rate, the era of cheap money is well and truly at an end. That will only make it harder for other countries to maintain lax monetary policies.

You can read more about what the end of Japan's ZIRP means for the global economy here: How stoozing could bring down the global economy.

Turning to the stock markets...

The FTSE 100 was floored as oil prices hit a record, falling 95 points to 5,765. Miners were among the main losers as fears that interest rates will rise to curb inflation outweighed rising commodity prices. Indian miner Vedanta Resources fell 5% to £13.36. For a full market report, see: London market close.

The markets also fell sharply in continental Europe, with the Paris Cac-40 falling 89 points to close at 4852. The German Dax-30 was down 110 points to 5527.

Across the Atlantic, US stocks closed sharply lower. The Dow Jones Industrial Average lost over 100 points for the second session in a row, falling 166 to 10,846, while the S&P 500 closed 16 points lower at 1,242. The tech-heavy Nasdaq dropped 36 to 2,054, a nine-month low.

The Wall Street sell-off hung over Asian markets. In Japan, the Nikkei 255 fell 256 points to close at 14,845, the first time the market has fallen below the key 15,000 in two weeks. The Bank of Japan confirmed the first interest rate rise in 6 years, hiking the base rate by a quarter point to 0.25%.

Oil hit a fresh record high in New York this morning in the wake of events in the Middle East, as crude rose above $78 a barrel. Brent crude was also higher, climbing to $76.53.

Meanwhile, spot gold hit a seven-week high of $665 on safe-haven buying.

And in the UK this morning, Russian oil giant Rosneft has raised $10.4bn in the world's sixth-biggest initial public offering. Shares were sold at $7.55 each, near the top end of the indicated range.

And our two recommended articles for today...

What Japanese rate rises will mean for the US economy

- If last week's short-lived US stock market rally really was based on the expectation of a Federal Reserve interest rate freeze in the wake of weak manufacturing activity, then something is seriously wrong, says gold commentator Paul van Eeden. Can traders be so obsessed with the Fed's next move that they ignore the bigger picture? If they are, then they're in trouble: not only is US growth slowing, but Japanese rate rises are likely to exacerbate the weaknesses in the economy. To find out why, see: What Japanese rate rises will mean for the US economy

Which assets are most vulnerable to the credit crunch?

- What will happen when the flood of cheap money that has been driving the US economy slows to a trickle? Dr Marc Faber gives his predictions in Whiskey & Gunpowder. To find out which assets are most vulnerable in the short term, click here: Which assets are most vulnerable to the credit crunch?

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.